Passive management

Passive management is most common on the equity market, where index funds track a stock market index, but it is becoming more common in other investment types, including bonds, commodities and hedge funds. One of the largest equity mutual funds, the Vanguard 500, is passively managed. The two firms with the largest amounts of money under management, BlackRock and State Street, primarily engage in passive management strategies. The concept of passive management is counterintuitive to many investors. The rationale behind indexing stems from the following concepts of financial economics: The bull market of the 1990s helped spur the growth in indexing observed over that decade. Investors were able to achieve desired absolute returns simply by investing in portfolios benchmarked to broad-based market indices such as the S&P 500, Russell 3000, and Wilshire 5000. In the United States, indexed funds have outperformed the majority of active managers, especially as the fees they charge are very much lower than active managers. They are also able to have significantly greater after-tax returns. This holds true when comparing both, mutual fund and the passive benchmark with the money market account, but changes by taking differential returns into account. Some active managers may beat the index in particular years, or even consistently over a series of years. Nevertheless, the retail investor still has the problem of discerning how much of the outperformance was due to skill rather than luck, and which managers will do well in the future. At the simplest, an index fund is implemented by purchasing securities in the same proportion as in the stock market index. It can also be achieved by sampling (e.g., buying stocks of each kind and sector in the index but not necessarily some of each individual stock), and there are sophisticated versions of sampling (e.g., those that seek to buy those particular shares that have the best chance of good performance). Investment funds run by investment managers who closely mirror the index in their managed portfolios and offer little 'added value' as managers whilst charging fees for active management are called 'closet trackers'; that is they do not in truth actively manage the fund but furtively mirror the index.