Why the Active vs Passive Debate is Outdated

We need to re-examine what we call funds, says John Rekenthaler as there are more than just active and passive offerings now on the market

John Rekenthaler 8 July, 2016 | 10:46AM

Everybody knows that there are active funds, and there are passive funds. Those are the terms used across the industry – by investment consultants, financial advisors, the media, fund companies, you name it. Including Morningstar, our screeners permit users to sort by active and passive funds.

That language, however, has become outmoded. It was fine until about a decade ago, when active funds were active funds and index funds were not. But in recent years, it has strained to keep up with changes in the fund industry. The result? Confusion, as people use the same words to state different things.

‘Active’, for example, currently has two meanings. One is that a fund is managed, so that it does more than mimic an index. This definition is not as straightforward as it sounds, because index funds sometimes deviate from their benchmarks, so as to reduce trading costs. But in practice, one can usually draw the line. The other definition of active is any fund that incorporates a market viewpoint.

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About Author

John Rekenthaler

John Rekenthaler  John Rekenthaler is vice president of research for Morningstar.

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