Active funds

"Active" refers to high volumes of trading activity in money management. In practice, fund managers create dynamic portfolios in order to keep investors' money safe. From an investment company's perspective, mutual funds or hedge funds usually select specific securities (e.g., diversification) and hedging strategies (e.g., asset rebalancing) based on the fund manager's expertise.

Notably, high volumes of trading activity generate more transaction costs and taxes. Moreover, management fees are usually more expensive due to managers' workload. These costs could be phenomenal. Now the question is, when is it worth the costs?

Theoretically, actively managed funds are more profitable during bear markets because hedging strategies work. The reason is that hedging strategies narrow the gap between the largest gains and losses. On the one hand, active funds usually do not have extremely high returns. On the other hand, we expect to see steady and robust returns in the long term. That is a trade-off between returns and risks.

Since the Federal Reserve raised interest rates to fight inflation, the U.S. economy could face a recession. Under the circumstances, active funds have a chance to beat the market. Plus, active funds usually offer protection against downside risk, which means that an investment company may be able to provide a minimum rate of return. It helps investors avoid the impact of loss.

Passive funds

Passive funds include Index Funds and ETFs (Exchange-traded Fund). The prices of these funds track stock indices, such as Standard & Poor 500 and Dow Jones Industrial Average. Unlike active funds, a passive fund does not need many trades. So, it can lower transaction costs and taxes.

Historical data shows that passive funds outperform active funds in the long run. The main reason is that, in the last decades, the impact of bull markets was more significant than bear markets in the U.S. This also means that passive funds do well during a bull market. On the one hand, these passive funds will lose value following the indices' collapse when the indices sink into a bear market. On the other hand, active funds are much less affected by stock price vibrations because of hedging strategies. As mentioned above, the U.S. stock market is facing a potential recession due to a high inflation rate. That is why active funds may be able to beat passive funds in the future.