What are the differences between passive and active mutual funds?

In addition to classifying mutual funds by categories, mutual funds also can be classified by their specific investment style: Active or Passive.

Active mutual funds are ones where the investment manager tries to earn investment returns greater than their benchmark indices through investment selection and timing of purchases and sales. The majority of mutual funds in Canada employ an active investment style.

Passive mutual fund managers do not believe that it is possible to identify stocks as undervalued/underpriced or overvalued, to the extent that returns can be enhanced by a more active style.

In recent years, as markets have become more volatile, the passive mutual funds are facing growing competition from Exchange Traded Funds (ETFs). ETFs are the result of the investment industry’s continuous sales pitch that investors should not trade or try to time financial markets, but rather they should Buy and Hold their investments.

In addition, as more indices move from a set index structure to a more managed indices structure, investors are subconsciously realizing that their investment performance never quite achieves the performance of the indices. As a result, investors are giving up on active investment management and using indexed ETFs.

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