Active & passive fund management: What’s the difference? (2024)

FAQs

Active & passive fund management: What’s the difference? ›

In general terms, active management refers to mutual funds that are actively managed by a portfolio manager. Passive management typically refers to funds that simply mirror the composition and performance of a specific index, such as the S&P 500^® Index.

Key Takeaways

Active investing requires a hands-on approach, typically by a portfolio manager or other active participant. Passive investing involves less buying and selling, often resulting in investors buying indexed or other mutual funds.

Passive investing is cheaper than active investing because passive funds have lower expense ratios and transaction costs than active funds. This is because passive funds do not require active buying and selling of securities or extensive research and analysis.

The job of an active fund manager is to pick and choose investments, with the aim of delivering a performance that beats the fund's stated benchmark or index. Together with a team of analysts and researchers, the manager will 'actively' buy, hold and sell stocks to try to achieve this goal.

Typically, passive funds own most of the same securities, and in the same weightings, as their respective indices. Passive fund managers make no active decisions, potentially resulting in less trading – which reduces fund expenses as well as potential taxable distributions to shareholders.

Over the past decade, an annual average of only 27.1% of actively managed funds benchmarked to the S&P 500 beat it. There are a few reasons why stock pickers are stinking up the joint worse than they normally do.

Actively managed funds

Typically, an actively managed fund will seek to outperform a designated index or benchmark that aligns with its investment mandate. For example, the S&P 500 Index is used as a performance benchmark for a large-cap stock fund.

DISADVANTAGES OF PASSIVE INVESTING

Limitations to outperforming the market or take advantage of short-term opportunities. Unable to deviate from the performance of the underlying index or benchmark. Limited ability to invest in specific companies or sectors of interest.

What are the disadvantages of active management? ›

The main disadvantage of active management is the higher costs associated with the research and analysis required to generate alpha. Active managers must also overcome the increased risk of making errors in their decisions.

As well as a larger investment universe, active managers can choose how much to invest in a particular company, unlike passive funds where holding size is dictated by a company's market capitalisation.

Disadvantages of Active Management

Actively managed funds generally have higher fees and are less tax-efficient than passively managed funds. The investor is paying for the sustained efforts of investment advisers who specialize in active investment, and for the potential for higher returns than the markets as a whole.

Active management includes mutual funds and exchange-traded funds, as well as portfolios of stocks, bonds and other holdings managed by financial advisers. Among the benefits they see: Flexibility – because active managers, unlike passive ones, are not required to hold specific stocks or bonds.

Passively managed funds include passive index funds, exchange-traded funds (ETFs), and Fund of funds investing in ETFs. These funds follow a benchmark and aim to deliver returns in tandem with the benchmark, subject to expense ratio and tracking error.

Examples of passive gifts include donations with dues, event ticket sales that benefit the Foundation, raffles, and donations given in a member's name on behalf of the Lodge. Active gifts make donors feel good and give them a personal connection to the Foundation, inspiring them to give again in the future.

Passively managed funds include passive index funds, exchange-traded funds (ETFs), and Fund of funds investing in ETFs. These funds follow a benchmark and aim to deliver returns in tandem with the benchmark, subject to expense ratio and tracking error.

Actively managed investments tend to generate higher returns since they take on more risk. Passively managed investments have an average and stable return. Costs are high for active management strategies because the level of order placement is relatively frequent.