Mutual funds are attractive because they provide investors with a portfolio that has none of the risks associated with choosing individual securities. There are many types of mutual funds, but all of them can either be passively or actively managed. How can you tell if yours is actively managed?
You can tell if a mutual fund is actively managed by looking at the main features covered in the key information documents for the investment, as providers typically offer a clear description. Actively managed mutual funds also tend to have higher expense ratios and management fees.
In this article, I’ll go over all you need to know about actively managed mutual funds to help you identify them as quickly as possible. So, without further ado, let’s get started!
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Table of Contents
How Do Mutual Funds Work?
Mutual funds are investment vehicles that allow you to combine your money in a pool alongside other investors to buy a portfolio made of a collection of assets, which are typically stocks and bonds.
With mutual funds, you can invest in a portfolio your capital won’t afford otherwise.
There are many types of mutual funds. Some of the options you can expect to find on offer across various companies include:
- Small-cap mutual funds
- Mid-cap mutual funds
- Large-cap mutual funds
- Industry-specific mutual funds (such as communications, biotechnology, automobiles, media, construction, and more)
- Foreign economy mutual funds (such as European, Asian, or African funds)
Whatever the option you choose to go with, mutual funds ensure you can pick a portfolio containing different stocks.
There’s no risk of putting too much on one stock, as would be the case when you try to pick individual stocks by yourself. You also won’t have to spend a lot of time sifting through tons of paperwork as you try to monitor the health of different companies across multiple industries.
Your mutual funds can be actively managed or passively managed.
What Is an Actively Managed Mutual Fund?
An actively managed fund is one where a manager (or a team of managers) works together to decide on how best to invest the fund money. They must constantly tweak the constituent securities of the mutual funds to generate market-beating returns.
How To Identify an Actively Managed Fund?
There are a few ways to identify an actively managed fund. Let’s take a closer look at some of these methods.
The Expense Ratio
The expense ratio is the fee charged by an investment company to manage investor funds.
Providers of mutual companies typically incur different operating expenses as they manage investor funds, so they charge a small fraction of the funds under management to offset the costs.
The expense ratio on any actively managed mutual funds will typically be between 0.50% and 1.5%. The money deducted covers:
- The management cost
- The management fee
- Legal costs
- Advertising costs
- Administrative fees
So, if you’re paying anything more than 0.50% of your fund as the cost of your investment, you’ve likely invested in actively managed mutual funds.
The Investment Description
Most investment companies often clearly state the type of management adopted for any mutual funds. So, actively managed funds will be clearly labeled.
The documentation provided online or in print will also cover such details.
If you’re unsure about the content of your investment brochure, reaching out to the investment company’s support desk should clarify any confusion.
The Mutual Funds Name
A widely known trick for distinguishing actively managed funds is that they typically don’t include the word “Index.” I’ll get to why investment companies don’t use the word in this cadre, but that’s just one of the easiest ways to see at a glance whether you’re looking at an actively managed fund or not.
What Are the Pros and Cons of Actively Managed Mutual Funds?
Below are some of the arguments for and against actively managed mutual funds.
Pros Of Actively Managed Funds
Above Average Returns
Actively managed funds increase the probability of generating above-average returns. Fund managers can make decisions to drive the best possible returns for investors, adding and removing stocks to the fund where necessary, using unique entries and exits.
Faster Investment Goal Actualization
Some actively managed funds can post outsized returns from time to time, which helps investors reach their investment goals faster if the good results continue consistently. Individuals investing with a time limit and a target return in mind can benefit from such an investment.
Relaxed Investing
Actively managed funds can help you save time and energy. An investor doesn’t need to spend too much time combing through the various components of the fund. As mentioned above, combing through dozens of company reports while trying to keep an eye on a portfolio is too much work for the average investor.
Cons Of Actively Managed Funds
General Underperformance
Although there’s the possibility of beating the market index, most actively managed funds tend to underperform. This Dow Jones data report showed that most large-cap mutual fund managers failed to outperform the S&P 500 in 2016, with more than 90% of them failing to beat the market over a 15-year window.
Taxes and Fees
Taxes and fees from selling a holding can diminish an active fund’s performance. Actively managed funds typically rotate holdings heavily over the lifespan of the funds and the resulting fees, and taxes, which eat away at the profits generated.
Fixed Management Fees
The management fees are fixed regardless of the fund’s performance, which could mean worse performance in bad years and average performance in good years. An example of this might be where you’re paying a 1.5% management fee in a year where the funds returned 5%.
Passively Managed Funds as an Alternative
Passively managed mutual funds are the opposite of actively managed types.
There’s no fund manager or a team of managers deciding where your money goes and the fund is designed to follow a specific market index. The S&P 500 is the popular option, but the fund can also track other popular market indexes.
The focus on indexes is why the name of actively managed funds doesn’t contain the word “index.” When you see the word in the description of a mutual fund, it’s most likely a passive portfolio.
What Are the Advantages of Passively Managed Mutual Funds?
If you’re wondering what type of mutual fund to choose, whether it be passively managed or actively managed, and you’re confused about the differences between them, keep reading to learn some of the advantages and disadvantages of passively managed funds.
Affordability
Passively managed funds often charge less than a tenth of the fees you’ll pay on an actively managed portfolio because the company doesn’t need to employ a fund manager. The low overhead is passed on to clients by way of reduced fees.
Over the lifespan of an average investment, this can add up to sizable savings in fees.
Higher Chance of Profits
Passively managed funds are also tax efficient because there’s not much trading going on, which means generating a less taxable income overall. A combination of these factors contributes to higher profits because you can keep most of the returns generated for any period under review.
Better Diversification
Indexes generally contain hundreds of securities, which offer much better diversification compared to actively managed funds. You’ll need a small army of managers to maintain an actively managed fund with 500 securities.
With passive mutual funds, everything can be automated.
The Main Disadvantage of Passively Managed Mutual Funds
The one major downside to passively managed funds is that there’s no room to beat the market. For example, if the fund tracks the S&P 500, it’s impossible to generate better returns than the index will post for any given year.
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Conclusion
You can recognize an actively managed fund by the higher fees charged and the name of the investment. If the fund isn’t readily distinguishable by these factors, reading the investment document can provide all the answers you need.
Remember to adequately compare the pros and cons of actively managed funds against passively managed options before buying into the investment.
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