Canadians are enthusiastic investors of mutual funds and exchange-traded funds (ETFs): of the 64% of Canadians who are investors, 61% have mutual funds, and 24% have ETFs. Investors appreciate the value these investment products can bring to a portfolio — especially the instant diversification they offer to help savings grow — yet many are less familiar with the difference between active and passive investment approaches.
Both mutual funds and ETFs pool money from many investors, allowing the fund to purchase a wide range of stocks or bonds. This creates diversification that would be difficult and costly for most individuals to build on their own, while also providing access to securities (stocks, bonds, etc.) and markets that may otherwise be out of reach. In turn, these investment products can help manage risk and deliver returns through capital growth, interest and dividend payments.
While each fund is built around a specific goal — for example, investing exclusively in U.S. companies or replicating the performance of the S&P 500 Index — the way that goal is achieved depends on how the fund is managed. This is where the distinction between active and passive strategies becomes important. Let’s explore the key differences between the two.
The difference between actively managed funds and passively managed funds
Mutual funds and ETFs can be managed in two ways: actively or passively (index-based). Understanding the differences between them — and how each can help to grow your wealth — is key to building a portfolio that works for you.
What are actively managed funds or ETFs?
Professional portfolio managers oversee actively managed funds or ETFs, making decisions on which securities to buy, hold or sell. The goal is often to outperform a specific market benchmark, such as the S&P/TSX Composite Index (an index that represents around 70% of the value of companies on the Toronto Stock Exchange).
The portfolio managers’ expertise is crucial for actively managed funds. Managers conduct in-depth research, evaluate a company’s management team, business plan and financial statements, analyze market and sector trends, and use analysts and economic forecasts to identify undervalued or high-potential investment opportunities. This hands-on approach allows them to adjust the fund’s holdings in response to changing market conditions, aiming to generate stronger returns than the overall market.
Actively managed funds can also provide access to segments of the market not included in typical indices, which are often unavailable to individual investors. These include alternative investments, such as private investments, real estate or infrastructure projects. For people looking to invest beyond traditional stocks and bonds, these funds can provide unique opportunities for diversification and enhanced returns.
Active managers can also excel in focusing on specific investment themes or sectors. For example, they may choose companies that are leaders in reducing carbon emissions or demonstrate strong environmental, social and governance (ESG) practices. Some may focus solely on specific sectors, like energy or technology. Others may focus on finding stocks that appear to be undervalued (known as value investing). They may also focus on companies with steady earnings to help reduce portfolio volatility. Actively managed funds allow investors to benefit from the experience and expertise of international fund managers to help improve the returns from their investments.
What are passive funds?
Passive ETFs or funds aim to replicate the performance of a specific index, such as the S&P 500 (an index that tracks the performance of around 500 of the U.S.’s largest companies). For example, if the S&P 500 increased in value by 8% over a year, an S&P 500 index fund would aim to provide a similar return, after accounting for fees.
Instead of selecting securities based on research or forecasts, they simply hold the same companies as the index and in similar proportions. Because of their structure, index funds need less effort from their asset managers, which means lower costs for investors.
The pros and cons of actively managed funds
It’s important to weigh up the pros and cons of actively managed funds so you understand the potential risks and rewards of investing in them.
Pros of actively managed funds:
- Potential for higher returns: skilled managers can outperform the market, using their expertise, resources and advanced data models.
- The ability to react to market changes: managers can switch up the composition of the funds, reduce exposure to riskier assets or increase cash holdings.
- Access to specialized investments: actively managed funds allow investment in private markets and alternative strategies that may not be available through passive funds.
- Thematic and ESG investing: investors can align their portfolios with personal values, such as sustainability or social responsibility.
- Actively managed risk: portfolio managers continuously evaluate the companies and sectors they hold, monitor market and economic signals, and make adjustments to reduce exposure to emerging risks while positioning the portfolio for opportunities.
Cons of actively managed funds:
- Higher fees compared to passive investments: due to the costs associated with research, trading and management, actively managed funds typically have higher expense ratios.
- No guarantee of outperformance: some managed funds may not perform better than their benchmarks.
- Manager risk: performance depends on the skill and decisions of the portfolio manager, so choosing the right one is important.
- Tax inefficiency: active strategies usually trade more frequently than passive strategies, which increases the likelihood of realizing capital gains and distributing them to investors. This may increase your tax liability in non-registered accounts (those accounts that are not RRSPs, TFSAs, etc.).
Building a balanced portfolio: why you might need a selective mix of both
Diversification does not only apply to what you invest in, but also to how those investments are managed. Incorporating both passive and active strategies adds another layer of diversification to your portfolio.
Passive exposure delivers efficient, low-cost access to an index’s performance, while active managers can selectively allocate capital, manage risk and try to deliver higher returns. Blending both approaches can strengthen portfolio construction and improve the ability to navigate different market environments.
How an IG Advisor can help you get the right balance
The right investment strategy depends on your personal goals, risk tolerance, time horizon and values. Your IG Advisor will take all of these into account (as well as your overall financial plan) when building your investment portfolio.
IG works with a group of some of the best portfolio managers from around the world, including J.P. Morgan, BlackRock, Northleaf and Mackenzie Investments, which have all been selected for their specialized investment expertise. Many of IG’s actively managed funds have received four- and five-star ratings from Morningstar (an independent research company that provides ratings for investment funds).
Your IG Advisor can also help you:
- Identify the right mix of active and passive funds, plus other assets for your portfolio, based on your goals and risk tolerance.
- Choose funds that align with your goals, such as saving for retirement or your child’s education.
- Ensure your portfolio remains aligned with your financial goals by continuously rebalancing the asset allocation.
- Minimize taxes by strategically placing investments in the most tax-efficient accounts (such as a TFSA or RRSP) or Series T.
Talk to your IG Advisor about how actively managed funds can help your portfolio grow. They’ll help you evaluate your options, understand the trade-offs and create a strategy that’s built to last, so you can invest with confidence today and in the future. If you don’t have an IG Advisor, you can find one here.
Written and published by IG Wealth Management as a general source of information only. Not intended as a solicitation to buy or sell specific investments, or to provide tax, legal or investment advice. Seek advice on your specific circumstances from an IG Advisor.
Commissions, fees and expenses may be associated with mutual fund investments and the use of iProfileTM Managed Asset Program. Read the prospectus and speak to an IG Advisor before investing. Mutual funds are not guaranteed, values change frequently and past performance may not be repeated. An asset allocation service, iProfile is a managed asset program for clients with a minimum of $250,000 invested in the iProfile program. Mutual funds and investment products and services are offered through the Mutual Fund Division of IG Wealth Management Inc. (in Quebec, a firm in financial planning). And additional investment products and brokerage services are offered through the Investment Dealer, IG Wealth Management Inc. (in Quebec, a firm in financial planning), a member of the Canadian Investor Protection Fund.
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