Investor Education

Episode 5 - Understanding active and passive funds

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Episode 5 - Understanding active and passive funds

Active funds aim to outperform the market through professional stock selection and timing, while passive funds track a market index to deliver broad exposure at lower cost. Investors should choose the right tool for their goals. Watch the video to learn more.

Making a choice between active and passive investments 

  • Investment funds are like baskets filled with different investments. The funds are used to buy assets, like shares and bonds in various companies.
  • Many people choose funds because they (1) offer access to many investments at once and (2) are considered a less risky approach compared with buying a single security like a company’s shares or bonds.
  • However, investors might feel overwhelmed by the many choices of investment funds. One key decision is whether to go for an active or passive investment approach.

Active investing – Buy and sell securities based on expertise 

  • Active funds are normally managed by fund managers who make investment decisions on behalf of investors. These managers conduct research and analysis to monitor markets and trade securities, aiming to achieve higher returns than the market or a benchmark index.
  • For example, if the MSCI World Index (a benchmark index) rises by 5%, the fund may aim to outperform it. Conversely, if the index falls by 5%, the fund may strive to limit losses to less than 5%, thereby beating the benchmark.
  • Remember, past performance doesn’t guarantee future results. Consistent long-term performance across various market conditions is often a more reliable indicator than short-term gains.

Some key elements for actively managed funds :

Research and analysis

Research and analysis

Pick stocks or bonds using expertise

Pick stocks or bonds using expertise

Determine the size of each holding

Determine the size of each holding

Determine when to enter or exit each position

Determine when to enter or exit each position

Passive investing – Track a market index 

  • Passive investing is an investment strategy where you invest in a fund that tracks a market index, such as the S&P 500 or the Hang Seng TECH Index. The goal is to match the performance of the index, rather than outperform it.
  • Passive funds, such as index funds or ETFs (exchange-traded funds), hold a mix of stocks or bonds that mirror a specific market index. Since this approach requires minimal management, these funds typically have lower fees.

Some key elements for passively managed funds :

Aim to replicate a specific market index

Aim to replicate a specific market index

Minimal management

Minimal management

Generally charge lower management fees

Generally charge lower management fees

Comparing passive and active investing 

According to LSEG Lipper, global passive equity funds' net assets stood at a record US$15.1 trillion at the end of December 2023, while active funds amounted to US$14.3 trillion. This means that the split between global equity funds are 51% passive and 49% active. 

Source: LSEG Lipper, as of December 31, 2023 

  Pros Cons
Active investing
  • Potential for higher returns relative to benchmark index
  • Customizable portfolios
  • Managers can react to market changes
  • No guarantee of beating the market
  • May underperform the market
  • Higher costs / fees that may potentially reduce long-term returns
Passive investing
  • Easy diversification, as benchmark indices are typically designed to represent the overall market
  • Lower management fees
  • Returns are limited to matching the performance of the market index
  • Lack of flexibility, as passive funds remain invested in the index regardless of market conditions

Factors to consider
  • In our view, for people who don’t have time to research active funds, passive funds might be a good choice. They’re a low-cost way to invest without needing to pick individual stocks. Passive investing can also help reduce stress, as it removes the pressure of trying to outguess the market.
  • On the other hand, if you prefer having a professional manage your investments—especially across multiple asset classes like stocks and bonds during different phases of the economic cycle—an actively managed multi-asset fund might be more suitable.
  • In our view, you don’t have to choose just one approach. Combining active and passive funds may create a balanced portfolio that matches your risk tolerance and investment goals.

Investment risks

The value of investments and any income will fluctuate (this may partly be the result of exchange rate fluctuations) and investors may not get back the full amount invested.