Active Funds and Passive Funds (also known as Tracker Funds or Index Funds) are somewhat true to their definitions. An Active Fund is actively seeking opportunities to beat a benchmark while a Tracker Fund is looking to mirror the performance of something such as an Index, so by its nature its more passive in its approach.
Firstly, it’s important to note that Active and Passive Funds are not ‘sectors’ in themselves, they are just a way to broadly distinguish between two types of funds.
Active Funds: Trying to build muscle
Active Funds are fun by a fund manager is active in selecting investments to hold in a fund with the aim of beating a ‘benchmark’ such as exceeding the average performance of the shares that make up the FTSE 100. The fund manager will be part of an investment house and will be supported by a team of analysts they look to actively ensure a good return on investment.
The sectors of funds that fall into this category could be Equity Funds as an example in which the fund manager will actively select shares to invest in. Unlike a Passive Fund, the fund manager can actively look to sell shares and buy ones in different companies if they don’t perform as hoped.
In comparison to Passive Funds, Active Funds tend to have a higher ongoing charges figure – reflective of the more effort involved by the fund manager.
Passive Funds: Trying to stay in good shape
Passive Funds also known as Tracker Funds simply try to mirror the performance of something, such as the FTSE 100. This is the big difference between this type of fund an an Active Fund. There is no fund manager actively searching for the best prospects to invest in.
If a Tracker Fund was tracking the FTSE 100 – it would work by buying shares in all 100 constituent companies in proportion to the overall value or market capitalisation of them. This way the Tracker Fund will mirror the movement of the FTSE 100. If the FTSE 100 rises, you gain, if it falls, you lose.
As Passive Funds don’t have such active management, you do benefit from a much lower ongoing charges figure.
Both come in handy
There is no hard and fast rule that you should adopt one type of fund over the other. An Active Fund has a benefit in that it is actively trying to exceed performance of a benchmark, but the potential downside is that it chooses the wrong investments and doesn’t even match let alone exceed the performance. Likewise a Passive Fund has the key benefit of tracking an index or price of something – so if it rises, you definitely gain and its cheaper to invest in.
However, it’s not a choice you have to make. As an example, a well-diversified portfolio could use Tracker Funds to give it cheaper exposure to developed markets and track the performance of the FTSE 100 or US Indices such as the Nasdaq 100, however it will likely use Active Funds for higher risk areas such as Emerging Markets. These markets such as Brazil and China arguably need the active approach of a fund manager to navigate a very different landscape and pick the best opportunities based on strong analysis.