A passively managed fund is a pool of investment instruments that rarely change because they follow an established benchmark, such as the S&P 500. Passively managed funds do not try to beat the market as actively managed funds do.

Definition and examples of a passively managed fund

A passively managed fund does not require any active management, such as the elimination or replacement of underperforming investments. In these funds, managers generally buy and hold securities so that the fund matches the performance of a benchmark index.

Alternative name: Index fund For example, the Vanguard Growth Index Fund Admiral Shares (VIGAX) tracks the CRSP U.S. Large Cap Growth index. VIGAX holds 265 stocks, including Apple, Microsoft, Google and other well-established companies. Because it buys the stocks listed in the index, the fund does not need active involvement unless the index changes.

An investment fund is a company with a management team. The team chooses an index to follow based on the fund’s strategy and objectives, buys the shares or other investments that will make up the holdings and offers the fund’s shares to investors.

The fund manager will follow the index or strategy and will not use his discretion in selecting investments, because the index or strategy dictates the holdings. After the fund is established, it essentially operates on autopilot unless the index changes.

It is important to note that most passively managed funds follow indices. This is why they are also known as index funds.

Due to their almost unmanaged nature, passively managed funds tend to have lower costs and lower capital gains distributions. This translates into greater tax efficiency for the investor than actively managed funds.

What it means for individual investors

Since passively managed funds almost always track indices, many of the standard investment mantras are adhered to:

• Diversify your portfolio
• Invest in what you know
• Don’t chase performance
• Don’t get emotional

Passively managed funds reduce risk because they follow market benchmarks that are designed by leading analysts. Because you are investing in a fund, you are gaining exposure to all the holdings within that fund, many of which are family businesses.

Index funds diversify your portfolio and reduce risk at the same time - they also eliminate the need to succumb to your emotions, because the companies in most indices have weathered several economic crises and market fluctuations.

Types of passively managed funds

There are many different types of passively managed funds. Index funds are the best known, but many different categories of funds use stock indices based on factors such as market capitalisation or sectors. Here are some examples.

Equity index funds

The S&P 500 is a popular benchmark for many funds. An index fund that attempts to mimic the returns of the S&P 500 will keep stocks (or most stocks) within the S&P 500. Other index funds may follow the Dow Jones Industrial Average, the Russell series (1000, 2000, 3000, 5000), or other stock indices.

Bond index funds

Bond index funds follow indices that consist of bonds. For example, the Bloomberg Aggregate Bond Index and the S&P U.S. Aggregate Bond Index list bonds hand-picked by experts from Bloomberg and Standard & Poor’s. For example, brokers such as Blackrock offer bond funds like the iShares U.S. Aggregate Bond Index Fund, which tracks the Bloomberg Aggregate Bond Index. Also known as the “Agg”, this index represents most of the available bonds.

Market Capitalisation Funds

Market-capitalisation funds can mimic indices that are benchmarked to the stock market such as the S&P 500, but will follow these indices based on the market capitalisation of the companies in the index. For example, the S&P 500 is a large capitalisation index, while the S&P 400 is a mid-capitalisation index. The Russell 2000 is an index of small capitalisation stocks.

Sector funds

Sector funds focus on specific sectors such as energy, healthcare, consumer goods or finance. For example, the MSCI ACWI Energy + Utilities index is used by Vanguard in its Energy Fund Admiral Shares.

Are passively managed funds worth it?

A passively managed fund has lower management costs because there is no fund manager making decisions about where to invest the money. Its performance will be equal to that of the underlying index. In 2021, passively managed funds prevailed despite the gains of actively managed funds. According to Morningstar’s Active/Passive Barometer, 45% of active funds outperformed their passive peers, meaning that 55% of passively managed funds outperformed actively managed funds.9

Passively managed funds may be a suitable choice for conservative investors who have no desire to outperform the market, due to performance and lower fees.

Key points

• Passively managed funds are designed to follow an index.
• The absence of active decision-making by the fund manager means lower fees.
• Passively managed funds reduce management risk.
• Passively managed funds tend to outperform actively managed funds.
• They are good choices for people who are not trying to beat the market.

Source of this article: www.thebalance.com