Loading the player...

DEFINITION of 'Passive ETF'

Passive ETFs are a vehicle to track an entire index or sector with a single security. Investors can buy and sell funds throughout the trading day, just like stocks on a major exchange. This provides them with greater flexibility to execute a buy and hold strategy without the aide of an actively managed fund. Using a passive approach has additional benefits of lower expense ratios, increased transparency and greater tax efficiency. For these reasons, investors have moved large blocks of assets from active funds into passive ETFs in recent years. State Street's $230 billion SPDR S&P 500 ETF is the most widely held passive fund, listed under the ticker symbol SPY

BREAKING DOWN 'Passive ETF'

Passive ETFs represent a large portion of fund flows over the past two decades. In July 2017, US ETFs topped $3 trillion in assets under management between passive, active and other types of strategies. Some key features of the passive industry have helped support the recent surge of deposits; costs, flexibility and transparency. Components of a passive ETF is determined by the underlying index or sector instead of the discretion of a fund manager. Taking a hands-off approach means the provider can charge investors less without having to worry about the cost of employee salaries, brokerage fees and research. The strategy also touts the benefit of lower turnover. When assets move in and out of the fund at a slower pace, it leads to fewer transaction costs and realized capital gains. By doing so, investors can save when it comes time to file their taxes. Meanwhile, passive ETFs are more transparent than an actively managed investment. Providers publish fund weightings each day, giving investors an opportunity to limit strategy drift and identify any duplicate investments. 

Passive ETFs operate like unit investment trusts (UITs) in that they reset at regular intervals. The fund provider also doesn't generate internal capital gains like actively-managed funds. However, they differ from UITs in that they can be bought and sold throughout a normal trading day. 

Risks of 'Passive ETFs'

Critics of passive investing claim the hands-off approach can't withstand the pressure of a down market. An active manager can rotate between sectors to shield investors from periods of volatility, but a passive fund that seldom adapts to market conditions may take the brunt of a drawdown. That said, the recent bull market has failed to bring about conditions where an active fund could outperform a passive strategy. 

RELATED TERMS
  1. Passive Activity Loss Rules

    Passive activity loss rules are a set of IRS rules that prohibits ...
  2. Passive Income

    Passive income is earnings derived from a rental property, limited ...
  3. Actively Managed ETF

    An active managed ETF is a form of exchange-traded fund that ...
  4. Suspended Loss

    A capital loss that cannot be realized in a given tax year due ...
  5. Active Index Fund

    Active index funds track an index fund with an additional layer ...
  6. Stock Exchange-Traded Fund (ETF)

    A stock exchange-traded fund (ETF) is a security that tracks ...
Related Articles
  1. Investing

    5 Common Misconceptions About Passive Investing

    Be aware of these 5 misconceptions about passive investing when deciding between passive and active.
  2. Investing

    Active Management Case Study: Comparing Index to Actively Managed Fees (MORN)

    Find out how actively managed funds compare with passively managed funds in terms of cost and whether higher cost funds outperform lower cost funds.
  3. Investing

    Why Your Passive Fund Is Crushing Active Managers

    A new study shows passive funds outperformed over 5, 10 and 15 years
  4. Investing

    Passively Managed Vs. Actively Managed Mutual Funds: Which is Better?

    Learn about the differences between actively and passively managed mutual funds, and for which types of investors each management style is best suited.
  5. Investing

    Why Passive Investing Isn't Always a Winning Strategy

    New research suggests that passive investors don’t come out ahead all of the time, and active portfolio management still plays a viable role in investing.
  6. Investing

    The Link Between ETF Popularity and Debt

    There may be a link between a firm's weight in bond indexes and how indebted that firm is.
  7. Investing

    Want ETFs But Hate To Buy And Hold? Try Active ETFs

    Choosing between passive and active ETFs depends on your beliefs about active management's value.
  8. Investing

    How Investors Can Prepare for a Passive Investing Bubble

    A passive strategy in investments can create too much risk in your portfolio.
RELATED FAQS
  1. Passive vs Active Portfolio Management

    Understand the difference between active portfolio management and passive portfolio management, and how each strategy benefits ... Read Answer >>
  2. Should I invest in ETFs or index funds?

    Learn advantages to investing in exchange-traded funds, or ETFs, and index funds, and decide whether to include them in your ... Read Answer >>
  3. What exactly is an ETF portfolio?

    Learn what exchange-traded funds (ETFs) are and their advantages to investors, what a portfolio of ETFs is, and discover ... Read Answer >>
Hot Definitions
  1. Compound Annual Growth Rate - CAGR

    The Compound Annual Growth Rate (CAGR) is the mean annual growth rate of an investment over a specified period of time longer ...
  2. Net Present Value - NPV

    Net Present Value (NPV) is the difference between the present value of cash inflows and the present value of cash outflows ...
  3. Price-Earnings Ratio - P/E Ratio

    The Price-to-Earnings Ratio or P/E ratio is a ratio for valuing a company that measures its current share price relative ...
  4. Internal Rate of Return - IRR

    Internal Rate of Return (IRR) is a metric used in capital budgeting to estimate the profitability of potential investments.
  5. Limit Order

    An order placed with a brokerage to buy or sell a set number of shares at a specified price or better.
  6. Current Ratio

    The current ratio is a liquidity ratio that measures a company's ability to pay short-term and long-term obligations.
Trading Center