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The Active vs. Passive Framework, Updated

Catching up with the times

One Word, Two Meanings

Everybody knows that there are active funds, and there are passive funds. Those are the terms used across the industry--by investment consultants, financial advisors, the media, fund companies, you name it. Including Morningstar. The company's products permit users to sort by active and passive funds.

That language, however, has become outmoded. It was fine until about a decade ago, when active funds were active funds and index funds were not. But in recent years, it has strained to keep up with changes in the fund industry. The result: Semantic confusion, as people use the same words to state different things.

"Active," for example, currently has two meanings. One is that a fund is managed, so that it does more than mimic an index. (This definition is not as straightforward as it sounds, because index funds sometimes deviate from their benchmarks, so as to reduce trading costs. But in practice, one can usually draw the line.) The other definition of active is that a fund incorporates a market viewpoint.

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About Author

John Rekenthaler, CFA  John Rekenthaler has been researching the fund industry since 1988. He is now a columnist for Morningstar.com and a member of Morningstar's investment research department. John is quick to point out that while Morningstar typically agrees with the views of the Rekenthaler Report, his views are his own.

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