Camille Van Vyve
22 Nov 2024
Active ETFs, passive ETFs, index funds, traditional funds: what are the differences?
For a long time, ETFs have been synonymous with passive investing, offering low-cost management aligned with market indices. However, their growing popularity has led to the emergence of subcategories and translations that often confuse investors. What’s the difference between a tracker and an index fund? Between an active ETF and a passive ETF? Between an active ETF and a traditional active fund?
A complex vocabulary
Trackers, index funds, passive ETFs, investment funds, active ETFs... In the world of finance, novice investors can quickly get lost. Adding to the confusion are trends and translations that make an already challenging vocabulary even more complex. For instance, while "tracker" was widely used a few years ago, the acronym "ETF" (Exchange Traded Fund) has since gained popularity. We now distinguish passive ETFs—synonymous with trackers as they follow or "track" an index—and active ETFs, which aim to outperform a benchmark index, much like traditional active funds.
Two key dimensions: stock listing and investment strategy
Simply put, these financial products can be categorized based on two essential dimensions: whether they are listed (or not) on the stock market, and their investment strategy (active or passive). The table above helps categorize these products at a glance.
Listing brings liquidity and transparency
Being listed on a stock exchange is a major differentiator as it significantly impacts investors. ETFs behave like stocks: they can be bought and sold throughout the trading day at market prices. This makes ETFs liquid products, easily tradable on markets, allowing quick entry into or exit from investments. Additionally, being listed ensures complete transparency: ETFs publish their portfolio holdings daily, enabling investors to know exactly what they own at all times.
Non-listed funds offer more flexibility
In contrast, non-listed funds can only be bought or sold at the end of the trading day at their net asset value (the value of all fund assets divided by the number of outstanding shares). They are less transparent, with asset disclosures often limited to quarterly reports, reducing investors' visibility into the exact portfolio composition. However, this has its advantages:
- protecting the fund manager's strategy from competitors
- reducing impulsive behavior by investors reacting to short-term fluctuations
- allowing fund managers greater flexibility to execute long-term strategies
Matching index performance at low cost
Investment strategy is the other key dimension that sets these products apart. Passive ETFs and index funds replicate the composition of an index (e.g., MSCI World, S&P 500). Their basket of stocks mirrors the index in similar proportions, with minimal adjustments, made only periodically to reflect index changes. The goal is to deliver the index's performance to investors while minimizing fees.
Paying more to try beating the market
On the other hand, active ETFs and funds also hold a basket of stocks, but the selection and weighting of these holdings are actively managed by a team. This team aims to seize market opportunities and outperform a benchmark index. While this strategy aspires to beat the market, it comes at a higher cost, especially for active funds. These funds not only charge high management fees but may also impose distribution fees and, in some cases, substantial entry fees.
Active ETFs are booming in the U.S.
While active ETFs are gaining traction, their success is most pronounced in the U.S., where ETFs enjoy significant tax advantages. This has led to a shift across the American fund industry toward ETFs, both passive and active. In Belgium, however, capital gains on stocks are not taxed. ETFs therefore do not offer a tax advantage over traditional funds and are still more commonly used in their passive form than in their active variant.
Passive ETFs: a global trend still worth riding
In 2023, passive funds surpassed active funds in total global assets under management. Passive ETFs, in particular, have become the most popular and rational investment option, being simple, liquid, cost-effective, and market-aligned. Promises of market-beating returns are increasingly difficult to justify—and to price—for active funds. Easyvest is the leader in passive ETF investing in Belgium. Want to get started? Run a simulation to find out what this strategy could bring you and make an appointment with one of our wealth managers.
In summary:
- The term “ETF” designates a listing method but says nothing about the manager's strategy. An ETF can be passive or active.
- The majority of ETFs are passive and follow a stock market index, hence the common confusion between ETF and passive or index management.
- Passive ETFs are very effective in the long term thanks to their low fees, simplicity and transparency.
- Active ETFs are becoming more and more popular. Despite their ETF nature, they remain active funds and generally struggle to do better than stock indices.
- There are also index funds not listed on a stock exchange. They are neither better nor worse than passive ETFs, they just work differently.