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Active versus passive funds - a two-minute explainer

A two-minute explainer on how index trackers and other such vehicles differ from actively managed funds

THoughtful fund manager

Investment funds generally fall into two camps: actively managed funds and passively managed funds.

An actively managed investment fund will be overseen by a fund manager who will seek to use his or her expertise to outperform the market and will charge management fees accordingly.

A passively managed fund will usually attempt to build a portfolio that mirrors a specific index, such as the FTSE All-Share. As such, the fund can effectively be run on auto-pilot, which results in much lower management fees. 

Bizarrely, an index-tracking fund that actually outperforms the index it is meant to be tracking will lose brownie points for this as it means the company running the fund can’t get its weightings right.

Be that as it may, if you invest in a fund that tracks an index that performs well, you are laughing and if you invest in one that performs badly, well, tough luck, sunshine.

READ: More evidence that it’s very hard to ‘beat the market’ over time, 95% of finance professionals can’t do it

Active fund managers, meanwhile, would argue that their experience and expertise increases the chance of outperforming the market. Well, they would say that, wouldn’t they?

Statistically speaking, most actively managed funds tend to do worse than the market index over a period of time.

Fund management companies will make great play of emphasising periods when one or more of their funds outperformed the market but as the warning on unit trust adverts says, past performance is no guide to future performance.

READ: ETFs - what are they, how to use them, risks, advantages and leverage

Most exchange-traded funds (ETFs) come under the passive category, though there are some ETFs companies that say they are actively managed.

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