What is the difference between active and passive fund performance?
The Bottom Line
Active investing involves fund managers making active decisions over what to invest in. Passive investors look to replicate a given index or market. Both strategies have their strengths and weaknesses. Where appropriate we look to blend different elements of active and passive within our strategies.
Active management requires frequent buying and selling in an effort to outperform a specific benchmark or index. Passive management replicates a specific benchmark or index in order to match its performance. Active management portfolios strive for superior returns but take greater risks and entail larger fees.
Typically, passive investments are lower cost, as investors are not paying for the fund manager's expertise in choosing the investments in the fund. Active funds, on the other hand typically charge a base fee and a performance fee, to incentivise the fund manager to produce the highest possible return.
Active asset management focuses on outperforming a benchmark, such as the S&P 500 Index, while passive management aims to mimic the asset holdings of a particular benchmark index.
Passively managed index funds face performance constraints as they are designed to provide returns that closely track their benchmark index, rather than seek outperformance. They rarely beat the return on the index, and usually return slightly less due to operating costs.
The objective of an active strategy is to achieve 'alpha' – in other words, to beat the market benchmark. “A passive strategy is more of a buy-and-hold strategy. You have to decide yourself when and how to reposition your exposure, whereas with active investing, it is done for you by the fund manager.”
Active strategies have tended to benefit investors more in certain investing climates, and passive strategies have tended to outperform in others. For example, when the market is volatile or the economy is weakening, active managers may outperform more often than when it is not.
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.
Whereas a passively managed ETF attempts to track the performance of a benchmark, actively managed ETFs have the opportunity to outperform the benchmark through investment decisions by portfolio managers and research analysts. Of course, the fund might underperform the benchmark as well.
What are 2 differences between active and passive?
The active voice asserts that the person or thing represented by the grammatical subject performs the action represented by the verb. The passive voice makes the subject the person or thing acted on or affected by the action represented by the verb.
Examples of Active and Passive Voice
The subject of the active voice example above is "he," the verb is "loves," and the object is "me." The subject of the passive voice phrase is "I," the verb is "am loved," and the object is "him." The active sentence's subject becomes the passive sentence's object.
Active investing can potentially generate higher returns but comes with higher costs and risks. On the other hand, passive investing aims for consistent returns with lower costs and less active decision-making.
What are passive funds? Passive mutual funds are funds which replicate a market index like the Nifty or Sensex. These funds invest in the constituents of the selected market index in the same proportion as they are present in the index.
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.
Over a third of active funds outperformed their passive counterparts in 2023, an uptick of nine percentage points from last year's 27%, according to AJ Bell's 'Manager versus Machine' report.
Index funds seek market-average returns, while active mutual funds try to outperform the market. Active mutual funds typically have higher fees than index funds. Index fund performance is relatively predictable; active mutual fund performance tends to be less so.
Active income, generally speaking, is generated from tasks linked to your job or career that take up time. Passive income, on the other hand, is income that you can earn with relatively minimal effort, such as renting out a property or earning money from a business without much active participation.
Pros and cons of passive investing
As the name implies, passive funds don't have human managers making decisions about buying and selling. With no managers to pay, passive funds generally have very low fees. Fees for both active and passive funds have fallen over time, but active funds still cost more.
Disadvantages of Active Management
Actively managed funds generally have higher fees and are less tax-efficient than passively managed funds.
What is an example of a passive fund?
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.
More than half of active funds and ETFs, 57%, outperformed their passive counterparts in the year from July 1, 2022, through June 30, 2023, an improvement from the 43% that did so the previous year, according to a new report from Morningstar.
The downside of passive investing is there is no intention to outperform the market. The fund's performance should match the index, whether it rises or falls.
Key Takeaways. Active risk arises from actively managed portfolios, such as those of mutual funds or hedge funds, as it seeks to beat its benchmark. Specifically, active risk is the difference between the managed portfolio's return less the benchmark return over some time period.
The long-term performance data show active management has a lot of catching up to do. Over the past 10 years, less than 7% of U.S. active equity funds have beaten the market, according to the Spiva U.S. scorecard .