Passive, it turns out, doesn't mean the same thing as indexed, so stop using the words interchangeably!

John Rekenthaler Morningstar, Inc. Vice President, Research

In a recent column, Morningstar's John Rekenthaler calls on fundsters to stop treating all indexed funds as if they're equally "passive." He warns the mutual fund industry that so-called smart beta (M* calls it "strategic beta") is indexed without being truly passive. The whole idea is to be smarter than just investing in everything. Rekenthaler calls smart beta funds the modern successors to quantitative (quant) funds.

Rekenthaler settles on a difficult active versus passive terminology, as envisioned by Morningstar's Tom Idzorek, who in turn drew the ideas from Morningstar's Don Phillips. They would divide funds into four groups, according to how they weight and implement their investments.

Truly passive funds use market capitalization weighting and passive implementation (i.e. investing in everything). Strategic beta funds use their own active, rules-based weighting systems but a passive implementation (i.e. investing in everything that fits the rules). Traditional active funds follow the traditional market weighting ideas to fit into their style boxes but then actively implement by picking their own stocks and bonds within their box. And "alternative active" funds both follow their own, active weighting and implement it their own way.

Active versus passive isn't a dichotomy; it's a spectrum. 

Edited by: Neil Anderson, Managing Editor


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