Active vs passive funds
When it comes to investing in funds, there's no shortage of options. But what are active and passive funds?
Before you start investing, it's good to understand the difference.
What are funds?
Investment funds are ready-made baskets of investments. You can invest money in a fund alongside lots of other people. That pool of money is used to buy assets, such as shares in different companies.
Many people invest in funds because they give you access to lots of underlying investments in one go and are typically lower risk than buying shares in individual companies.
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What are active investment funds?
If you're considering active funds, look at a manager's long-term track record across a variety of market conditions – good times and bad. Always keep in mind that past performance isn't necessarily a reliable indicator of future performance.Investing in actively managed funds is where a fund manager or a management team decides how to invest the fund's money.
The job of an active fund manager is to choose which investments to hold within the fund. They aim to outperform their fund's stated benchmark or index – such as the FTSE 100 – over time. For example, if the FTSE 100 goes up by 5% over 12 months, the fund would aim to provide returns of above 5%.
Together with a team of analysts and researchers, the manager will actively buy and sell stocks to try to achieve this goal.
What are passive investment funds?
Passive investing means investing in funds that aim to match the returns of a specific market or index. They don't try to beat it - they replicate the movement of the market they're tracking.
For example, a fund tracking the FTSE 100 will buy shares in all 100 companies in the same proportions as their market value. This means the value of the fund will move in line with the change in the value of the FTSE 100 Index.
Exchange Traded Funds (ETFs) are an example of passive funds. They're listed on stock exchanges and can be bought and sold like shares.
Active vs passive investment: which is the better option for you?
To help you decide which might suit your circumstances, here are some of the pros and cons of each:
| Pros | Cons |
|---|---|
| They make it possible to beat the market index | There's no guarantee an active fund will perform better than the index |
| Fund managers build diversified portfolios to manage the balance between risk and potential reward for investors | It's not enough to just beat the index – active funds have to beat it by at least enough to cover their expenses, such as transaction fees |
| They may be able to spot opportunities or react to market downturns by selling poor performing investments, for example | The cost of active investing tends to be higher, which can affect long-term returns |
| Pros | They make it possible to beat the market index | They make it possible to beat the market index |
|---|---|---|
| Cons | There's no guarantee an active fund will perform better than the index | There's no guarantee an active fund will perform better than the index |
| Pros | Fund managers build diversified portfolios to manage the balance between risk and potential reward for investors | Fund managers build diversified portfolios to manage the balance between risk and potential reward for investors |
| Cons | It's not enough to just beat the index – active funds have to beat it by at least enough to cover their expenses, such as transaction fees | It's not enough to just beat the index – active funds have to beat it by at least enough to cover their expenses, such as transaction fees |
| Pros | They may be able to spot opportunities or react to market downturns by selling poor performing investments, for example | They may be able to spot opportunities or react to market downturns by selling poor performing investments, for example |
| Cons | The cost of active investing tends to be higher, which can affect long-term returns | The cost of active investing tends to be higher, which can affect long-term returns |
| Pros | Cons |
|---|---|
| They can be an easy way to diversify within asset classes and markets | Your return depends entirely on the performance of the index being tracked, so if the market falls, so will the value of your investment |
| With no managers to pay, they generally have very low fees | You may be overly exposed to one asset class or market |
| Depending on the index and where they’re invested, passive funds can be less ‘risky' | There's no flexibility to avoid overvalued sectors or stocks, for example, in the financial crisis of 2008, when the FTSE 100 had a large weighting in banking stocks |
| Pros | They can be an easy way to diversify within asset classes and markets | They can be an easy way to diversify within asset classes and markets |
|---|---|---|
| Cons | Your return depends entirely on the performance of the index being tracked, so if the market falls, so will the value of your investment | Your return depends entirely on the performance of the index being tracked, so if the market falls, so will the value of your investment |
| Pros | With no managers to pay, they generally have very low fees | With no managers to pay, they generally have very low fees |
| Cons | You may be overly exposed to one asset class or market | You may be overly exposed to one asset class or market |
| Pros | Depending on the index and where they’re invested, passive funds can be less ‘risky' | Depending on the index and where they’re invested, passive funds can be less ‘risky' |
| Cons | There's no flexibility to avoid overvalued sectors or stocks, for example, in the financial crisis of 2008, when the FTSE 100 had a large weighting in banking stocks | There's no flexibility to avoid overvalued sectors or stocks, for example, in the financial crisis of 2008, when the FTSE 100 had a large weighting in banking stocks |
Before you invest, think about your own financial situation, your goals, and the amount of risk you're comfortable taking. If you're new to investing, you might want to talk to an adviser before making any investment decisions.
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Key takeaways
If you don't have time to research active funds or don't feel comfortable choosing between them, passive funds could be more suitable. They're a way of investing in individual sectors or regions without having to select active funds or individual stocks.
But it doesn't have to be a straight choice between one or the other. It's possible to build diversified portfolios by combining active and passive funds. If you choose to invest in a portfolio of investment funds, they will normally combine both active and passive funds.
With active funds, keep in mind that some have lower fees and a better track record than others. But a great performance over a year or two is no guarantee that the fund will continue to outperform. Instead, you might want to look for fund managers who have consistently outperformed over long periods.
Remember that the value of investments is not guaranteed, and you might not get back what you invested. Any income received from investments can fall as well as rise.
This could also happen as a result of changes in currency exchange rates - particularly where overseas securities are held or where investments are converted from one currency to another.
We always recommend that any investments held should be viewed as a medium to long-term commitment of at least 5 years.
For short-term goals, you could think about opening a savings account as an alternative to investing.
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Disclaimer
HSBC Bank plc, Jersey Branch has prepared this article based on publicly available information at the time of preparation from sources it believes to be reliable but it has not independently verified such information.
The HSBC Bank plc, Jersey Branch and the HSBC Group are not responsible for any loss, damage, liabilities or other consequences of any kind that you may incur or suffer as a result of, arising from or relating to your use of or reliance on this article. The contents of this article are subject to change without notice. HSBC Bank plc, Jersey Branch and the HSBC Group give no guarantee, representation or warranty as to the accuracy, timeliness or completeness of this article.
This article is not investment advice or a recommendation nor is it intended to sell investments or services or solicit purchases or subscriptions for them. This article should not be used as the basis for any decision on taxation, estate, trusts or legacy planning. You should not use or rely on this article in making any investment decision. HSBC Bank plc, Jersey Branch and the HSBC Group are not responsible for such use or reliance by you.
Any market information shown refers to the past and should not be seen as an indication of future market performance.
You should consult your professional advisor in your jurisdiction if you have any questions regarding the contents of this article.