There are two basic forms of investing: active and passive. We explain the features of active funds and passive funds and which of the two investment forms is better.
Content
| Differences at a glance | |
| What are passive funds? | |
| What are active funds? | |
| What is better: passively or actively managed funds? | |
| Investing passively with finpension |
Active vs. passive investing in funds: differences at a glance
| Active Funds | Passive Funds | |
| Fees | Fees are usually high | Fees are usually low |
| Strategy | Market timing, stock picking | Buy and hold |
| Transparency | Composition not publicly available | Composition of an index fund is publicly available |
| Performance | Excess performance possible | Market performance, no above-average gains possible |
What are passive funds?
Passive funds invest in an index and thus mirror the market. A passive fund does not decide which shares to invest in and how much, but always sticks to the target index.
If the index changes, the fund adjusts its investments accordingly. Since no investment decisions have to be made, the administration of a passive fund is less costly than that of an actively managed fund, and passive funds are, therefore, often significantly cheaper.
Thus, a passive fund allows you to achieve the market return at the lowest possible cost. Passive funds include in particular index funds and ETFs. BlackRock with the iShares brand is a well-known provider of ETFs.
What is an index?
An index is a collection of stocks traded on the stock exchange. An index allows you to see market movements quickly. Large companies usually have a large share in an index, while smaller companies have a smaller share. The weights of the individual stocks in an index always add up to 100%.
The simplest form of an index is the stock index of a specific stock exchange, such as the Swiss Market Index (SMI). In most cases, such indices (plural of index) are determined by the stock exchange operator itself. The rules for the composition of an index are publicly available. The rules are needed so that it is clear under which conditions the composition of the index is adjusted.
In addition to geographical indices such as the SMI, there are many other indices with different focuses. For example, there are sustainable indices (ESG indices) that only take into account companies with certain environmental and social standards. A well-known provider of such indices is MSCI.
In addition to stock indices, there are also indices for other investments such as bonds or real estate.
What are active funds?
Active funds do not follow an index. The fund makes its own investment decisions. For this purpose, the fund usually employs an asset manager. He decides when to buy or sell investments within the fund.
The asset manager’s goal is to outperform the market. How does the asset manager proceed?
The manager of an active fund tries to identify over- and undervalued stocks. The stocks he considers overvalued are sold, and undervalued stocks are bought. If the asset manager’s assessment is correct, he will achieve a better return.
Are active funds really active?
Many funds that are actively managed are only seemingly active. How is that possible? Active asset managers are aware that they are taking a big risk by deviating too much from the market. While this could lead to significantly better performance, it could also lead to significantly worse performance compared to passive funds. This is something that no fund provider can afford. Therefore, many active asset managers only deviate marginally from an index.
Despite this, many providers still call their funds “active”. There is a simple reason for this: Active funds are much more profitable for providers and a strong selling point. Many people believe that the higher costs are justified because the asset manager is actively managing the money. This sounds much better than if the asset manager were passive.
In addition, the market for passive funds is much more competitive. Since there are many funds that track the same index, they are easier to compare. And what is easier to compare is subject to more competitive pressure. Many Swiss banks cannot compete in the passive funds market, so they focus on the business of active funds.
What is better: passive ETF or actively managed funds?
Actively managed funds may indeed perform better than the market return in a given year. However, over the long term, the majority of actively managed funds cannot achieve outperformance. What remains over the long term are the higher costs, as shown in the following graph:
The area below the grey curve reflects all active funds available on the market. In the middle around the market average are the funds with an average performance (before costs). Towards the right (+) and left (-) there are fewer and fewer. This means that many funds are gathering around the average market return. Only a few funds achieve a significantly higher performance than the market average, just as few perform worse than the market average.
Deducting the cost of performance of active funds shifts the curve (red) to the left. It still looks the same. However, we can see that significantly fewer funds are now in positive territory (+ outperformance) below the red curve. The higher the costs are, the less likely it is that the actively managed fund will outperform the average market return (before costs).
What do studies say?
Several studies show that most active funds underperform the market. For example, the SPIVA study measures the performance of active funds over 1 to 10 years compared to their benchmarks. The 10-year performance shows active funds rarely outperform the market over the long term. According to SPIVA, the underperformance is usually between 80% and 93%.
Despite their promises, investors are left with a market return or even less in most cases. This is the case at higher costs and with more risk than with a passive ETF. Due to the compound interest effect, a passive investor therefore almost always has a higher net worth over the long term than an active investor.
Investing passively is easy and relaxed with finpension
We at finpension are convinced of the benefits of passive investing. That’s why we want to make investing as easy as possible for you. With our investment solutions for free assets, pillar 3a or portability, you always have an overview. Find out more.
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