A new report from Global X has explored the pros and cons of passive and active ASX ETFs.
The decision between active and passive is an important one for investors.
What's the difference?
There are now hundreds of ASX ETFs for investors to choose from.
ETF providers design these products in many different ways.
One key distinction is whether the fund simply tracks an index or is actively managed to beat the returns of an index.
Passive ETFs aim to track a market index. They follow a rules-based approach, holding securities in the same proportions as a benchmark such as a broad equity index like the largest 300 companies in Australia or a bond index.
An example would the Global X Australia 300 ETF (ASX: A300).
It seeks to provide investors with a return that tracks the performance of the FTSE Australia 300 Index.
Meanwhile, active ETFs aim to beat the market and do not track an index.
Portfolio managers make investment decisions, such as selecting securities, adjusting exposures, and responding to market conditions, in an effort to generate excess returns above the index.
Understanding fees
According to Global X, fees are often the most visible but misunderstood difference between the two approaches.
Passive ETFs are typically much cheaper because they don't require research teams or frequent trading.
Average expense ratios sit around 0.36% per year for passive ETFs (i.e. $36 per year for a $10,000 investment) versus roughly 0.78% for active ETFs (i.e. $78 per year for a $10,000 investment).
The $42 per year gap in fees may seem small, but over time it compounds. Higher fees reduce net returns year after year, which is why cost is often described as one of the few variables investors can control.
Why passive has gained market dominance
The report from Global X highlighted that passive investing has grown rapidly over the past two decades for the following reasons:
- Consistent returns – Passive ETFs are designed to deliver the return of the market. They also avoid the risk of underperformance tied to poor manager decisions and avoids key person risk if a particular fund manager decides to leave.
- Lower costs – With minimal trading and no need for stock-picking teams, passive ETFs pass cost savings directly to investors. Lower trading costs, reduced tax impacts, and lower overall fees all help ensure more of the returns remain in investors' pockets.
- Transparency and simplicity – Investors can easily understand what they own, as passive ETF holdings are typically disclosed daily and tied directly to an index. Active ETFs typically don't disclose their full holdings and sometimes only periodically reveal them with a three-month lag.
- Long-term evidence – After fees, many active managers struggle to consistently outperform benchmarks over long periods.
These factors have led to a market dominance in terms of funds under management for passive ASX ETFs.
A blended approach
According to Global X, there is a case to be made for a combination of both ASX ETFs.
Active ETFs may justify their higher fees when investors seek access to niche opportunities, enhanced risk management, or exposure to less efficient markets. In these cases, skilled managers can potentially add value.
They can also serve as a tactical complement to a broader passive investment portfolio.
Ultimately, the most effective portfolios are not built on ideology but on thoughtful allocation, where cost, conviction, and context all play a role.
The post Are passive or active ASX ETFs a better investment choice? appeared first on The Motley Fool Australia.
Motley Fool contributor Aaron Bell has no position in any of the stocks mentioned. The Motley Fool Australia's parent company Motley Fool Holdings Inc. has no position in any of the stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.
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