Definition
The term passive management refers to a portfolio manager that makes investments in an attempt to replicate the returns of a benchmark index. Passive managers do not use research reports when making investment decisions, they follow a pre-defined strategy that involves keeping the fund's assets in-line with the index they are mirroring.
Explanation
Also known as index investing, a passive management approach may apply to certain mutual funds and exchange traded funds (ETF). When passively managed, the fund's objective is to provide investors with a return equal to a market index such as the S&P 500. They do this by rebalancing the stocks in their portfolio to minimize its tracking error. Passive management is the opposite of active management, which is an investment strategy that attempts to outperform a market index.
Passive managers do not use research reports or attempt to "time the market" when making their investments. They follow a pre-defined strategy that replicates the returns of a market index. When executing this strategy, the management team attempts to keep the fund's transaction costs low.
Individuals that invest in passively managed funds typically believe in the efficient market hypothesis. They do not believe it's possible to outperform the market over the long-term, since the current price of a stock reflects all known information. Attempting to select undervalued stocks to buy, and overvalued stocks to sell short, is both pointless and inefficient.
Related Terms
active management, active return, tracking error
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