What Is a Passively Managed Fund?

Passively Managed Funds Explained

Definition

A passively managed fund typically tracks a market index, such as the S&P 500, or a particular sector. There is no active strategy for the fund manager to buy or sell.

Investor watching the markets
Photo:

gorodenkoff / Getty Images

Definition and Examples of a Passively Managed Fund

A passively managed fund does not require any active management, such as eliminating or replacing non-performing investments. In these funds, the manager(s) generally buy and hold securities so that the fund matches the performance of a benchmark index.

  • Alternate 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 stocks listed on the index, the fund doesn't need active involvement unless the index changes.

How Passively Managed Funds Work

An investment fund is a company with a management team. The team picks an index to follow based on the strategy and goals of the fund, purchases the stocks or other investments that will make up the holdings, and offers shares of the fund to investors.

The fund manager(s) will follow the index or strategy and will not use their discretion in selecting investments, because the index or strategy dictates the holdings. After the fund is established, it essentially operates on auto-pilot unless the index changes.

It's important to note that most passively managed funds track indexes. This is why they are also known as "index funds."

Note

Because passively managed funds need less management, they reduce the risk that fund managers might make bad or untimely decisions for the fund.

Due to their nearly unmanaged nature, passively managed funds tend to have lower expense ratios and lower capital gains distributions. That translates into more tax efficiency for the investor over actively managed funds.

What It Means for Individual Investors

Because passively managed funds nearly always track indexes, you comply with several of the standard investing mantras:

  • Diversify your portfolio
  • Invest in what you know
  • Don't chase performance
  • Don't become emotional

Passively managed funds reduce risks, because they follow market benchmarks that are designed by leading analysts. Because you're investing in a fund, you're gaining exposure to all of the holdings within that fund—many of which will be familiar companies.

Index funds diversify your portfolio and reduce risks at the same time—they also eliminate the urge to succumb to your emotions, because the companies in most indexes have made it through multiple economic crises and market fluctuations.

Note

Returns and past performance are never guaranteed, but passively managed funds (in the form of index funds) have tended to recover and continue slowly growing. The S&P 500 has an annual average return of 11.81%.

Types of Passively Managed Funds

There are many different types of passively managed funds. Stock index funds are the most well-known, but many different categories of funds use stock indexes based on factors like market capitalization or sectors. Here are a few examples.

Stock 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 hold the stocks (or most of the stocks) within the S&P 500. Other stock index funds can track the Dow Jones Industrial Average, the Russell series (1000, 2000, 3000, 5000), or other stock indexes.

Bond Index Funds

Bond index funds follow indexes that consist of bonds. For example, the Bloomberg Aggregate Bond Index and S&P U.S. Aggregate Bond Index list bonds hand-selected by the experts at Bloomberg and Standard & Poor's. For example, brokerages like 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 bonds available.

Note

Exchange-traded funds and mutual funds can both be passively managed, but most mutual funds are actively managed.

Market Capitalization Funds

Market capitalization funds can mimic indexes regarded as stock market benchmarks like the S&P 500, but they will track these indexes based on the market cap of the companies on the index. For example, the S&P 500 is a large-cap index, while the S&P 400 is a mid-cap index. The Russell 2000 is an index of small-cap stocks.

Sector Funds

Sector funds focus on specific sectors like energy, healthcare, consumer staples, or financial. 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 carrying costs, because there is no fund manager making decisions about where to invest the money. It will only perform as well as the underlying index. In 2021, passively managed funds prevailed despite gains by actively managed funds. According to the Morningstar Active/Passive Barometer, 45% of active funds outperformed their passive peers, meaning that 55% of passively managed funds outperformed actively managed funds.

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

Key Takeaways

  • Passively managed funds are designed to follow an index.
  • Having no active decision-making by a fund manager means lower fees.
  • Passively managed funds reduce management risk.
  • Passively managed funds tend to outperform actively managed ones.
  • They are good choices for people who aren't looking to beat the market.

The Balance does not provide tax, investment, or financial services and advice. The information is being presented without consideration of the investment objectives, risk tolerance, or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk, including the possible loss of principal.

Was this page helpful?
Sources
The Balance uses only high-quality sources, including peer-reviewed studies, to support the facts within our articles. Read our editorial process to learn more about how we fact-check and keep our content accurate, reliable, and trustworthy.
  1. Vanguard. "Vanguard Growth Index Fund Admiral Shares (VIGAX)."

  2. Financial Industry Regulatory Authority. "Mutual Funds: Active vs. Passive Management."

  3. New York University Stern School of Business. "Historical Returns on Stocks, Bonds and Bills: 1928-2021."

  4. BlackRock. "iShares U.S. Aggregate Bond Index Fund."

  5. Standard & Poor's. "S&P 500."

  6. Standard & Poor's. "S&P MidCap 400."

  7. FTSE Russell. "Russell 2000 Index."

  8. Vanguard. "Vanguard Energy Fund Summary Prospectus," Page 4.

  9. Morningstar. "Download Morningstar's Active/Passive Barometer." Requires email address and free sign-up.

Related Articles