The line between active and passive managers is not always clear. An article from the Journal of Indexes looks at the passive overlap of actively managed funds and the expenses charged. Passive overlap is the holdings in an actively managed fund that are exactly the same as the benchmark index. In effect, a fund that is marketed as active may be significantly passive.

One immediate benefit of indexing part of an active fund is that it reduces the tracking error of the fund to the benchmark. Lower tracking error is good if the index is well constructed. The problem arises when higher active manager fees are paid for what amounts to a significantly passive fund. To be fair, fund expenses have a wide range within both passive and active funds. Typically, however, active funds tend to have higher fees. Ideally, if passive overlap is very high, we would hope that the fund manager would charge a lower rate because the actively managed component is less.

In the regression analysis shown in the article, “there is little relationship between expense ratios and passive overlap.” So, whether there is 0% passive overlap or 60% passive overlap, this variable has little impact on the fund expense ratio. This doesn’t seem right.

One must ask, is this really an active fund, or is this an active fund with passive characteristics and typically active-style fees? It’s not Halloween all-year long, maybe the mask should be removed.