Let's look at the difference between active and passive investment management to understand some of the key differences between these two approaches to investing. The first difference to note is in terms of the aim of the fund. A passively managed fund aims to generate the same return as a benchmark or an index, which can be achieved through holding a portfolio of the same securities in the same weights as the benchmark. In contrast, an actively managed fund is trying to generate better returns than the benchmark, also referred to as generating alpha.

A good active fund is not simply one which generates good returns, but a fund which generates more than could have been achieved through a passive fund. Part of the logic behind investing in passive funds is that the investor may believe that securities are fairly priced, meaning that there is little point in hiring a fund manager to try and find mispriced securities since they don't exist to any great extent. However, actively managed funds are trying to beat the benchmark and to do so must believe they can find undervalued securities to invest more money into and overvalued securities to invest less in to beat the benchmark. Passive funds tend to be transparent as to which securities they hold since they will be very similar to the benchmark. However, active fund managers do not reveal their portfolios on an ongoing basis since this would reveal their strategy to beat the benchmark. Passive funds tend to engage in fewer transactions to buy and sell securities, and as such, tend to have lower trading costs, as well as lower management fees. Since there is no fund manager making investment decisions, the fee level is the main determining factor between different passive funds. Since tracking the benchmark is taken as a given, the lower the fees the better the passive fund. For active funds, there are higher costs through more frequent trading to enact the manager's decisions and also higher management fees to cover the costs of the work done by the portfolio manager to find mispriced securities and attempt to outperform the benchmark. When considering the outperformance of an active fund against a benchmark, it is vital to consider this after management fees. Since these will not be the same in both passive and active funds, passive funds will be highly correlated with their respective market, while the returns on active funds will deviate from the benchmark in their attempts to beat it, creating more dispersion of returns, and therefore lower correlation with the market itself. Passive funds are less reliant on manager judgment since they attempt to passively follow the benchmark. Although there is some decision making required when benchmarks are rebalanced or reconstituted. Active funds ability to outperform a benchmark is highly driven by the skill and judgment of the portfolio manager. An example of a passively managed fund would be an S&P500 ETF, which is attempting to generate the same return as the S&P500. And a hedge fund would be a good example of an actively managed fund attempting to generate as much return as possible given its particular strategy.