Passive, smart beta and active ETFs

Two ETFs hold almost the same hundred shares. The first replicates an index built on quality and volatility rules; the second allows the manager to change the weights when it believes the risk has changed. The final photograph can look similar. The process is not.

The distinction between active and passive management is not about how much the portfolio “moves”, how concentrated it is, or whether it uses algorithms. It is above all about where the discretion sits: in a predefined methodology, in the manager, or in a combination of the two.

Three questions before the labels

Before classifying an ETF, it helps to separate three objects:

• Objective: does the fund promise to replicate an index, beat a benchmark, or pursue a result with no replication constraint?
• Process: do decisions come from published rules, from discretionary judgements, or from both?
• Portfolio: how much, and in what way, do the positions differ from the benchmark used to evaluate it?

The answers do not coincide automatically. A portfolio can be very different from the market and remain passive, because it faithfully replicates a concentrated index. An active fund can instead stay close to its benchmark while holding the legal freedom to move away from it.

What passive management means

A passive ETF normally tries to reproduce the return of an index, net of costs and frictions. The manager does not freely pick the companies it considers best: it applies the index methodology and manages the replication.

This still requires operational decisions:

• full replication, sampling or optimisation;
• managing flows and liquidity;
• handling dividends, taxes and corporate actions;
• securities lending, collateral and counterparty management;
• participating in index reviews and rebalancings;
• managing the deviations produced by costs and constraints.

“Passive” therefore describes the exposure mandate, not the absence of work. Even a fund that physically replicates an index must turn theoretical rules into an investable portfolio.

The index makes decisions

Every index embeds choices: universe, liquidity requirements, free float, review frequency, treatment of countries, weight caps and rules for extraordinary events — this is the governance of indexes. A cap-weighted index is not neutral; it applies a rule that assigns more weight to the companies with the largest market value, adjusted per the methodology.

The decisions can be simple and stable, or numerous and selective. In both cases, if the fund’s mandate is to replicate that index, the management remains indexed.

That is why “passive” does not mean “whole market”. An ETF on a single sector, on thirty securities or on a heavily filtered ESG basket can be passive relative to its own index and, at the same time, represent a very specific investment choice.

What active management means

In an active ETF the manager has greater freedom to select, exclude, weight or replace instruments, within the limits of the prospectus. The benchmark can serve for comparison, risk control or fee calculation, without becoming a portfolio to replicate.

The discretion can cover:

• selection of individual securities;
• allocation across countries, sectors, duration or credit quality;
• currency exposure and hedging;
• the amount of cash held;
• the timing of changes;
• the use of derivatives and relative positions.

“Active” does not necessarily imply many trades. A manager can hold the same positions for a long time. What matters is the faculty to change them on the basis of a judgement, not merely to follow an external rule.

Active does not mean without rules. Every active fund operates within a mandate. It can have exposure limits, ESG criteria, risk budgets, duration ranges or constraints relative to the benchmark. A quantitative process can generate the proposals while a committee keeps the power to approve or modify them.

The opposition “passive algorithm versus active human” is therefore false. An algorithm can implement a passive index or a proprietary active strategy. A committee can exercise discretion or apply rigidly codified rules.

Indexed is not a synonym of traditional

The best-known indexes weight their components by market capitalisation, but indexing can use many other rules:

• equal weight;
• economic fundamentals;
• dividends;
• volatility;
• quality, value, momentum or size;
• climate or ESG objectives;
• maturity and credit quality for bonds.

A fund that replicates one of these indexes is indexed even when the result drifts far from the broad market. The correct comparison is not between “index” and “choices”, but between choices embedded in the methodology and choices exercised during management.

Smart beta and factor strategies

“Smart beta” has no universal legal definition. It generally identifies indexed strategies that replace traditional cap weighting with rules targeting one or more factors or outcomes.

These strategies are often passive in implementation, because they replicate an index, but active in the original economic choice: they decide which characteristics to reward and how to measure them. The useful expression is non-traditional indexing, not “magic halfway between active and passive”.

The factor’s name is not enough. Two ETFs called “Quality” can use different indicators, universes, constraints and rebalancing frequencies. One can neutralise sectors; the other not. One can cap individual weights; the other concentrate the portfolio heavily. The name describes a commercial intention. The index methodology and the prospectus describe the investable process.

Systematic and discretionary: a second axis

Active/passive and systematic/discretionary are not the same axis.

A quantitative active ETF can be more mechanical than an index governed by a committee. The classification depends on the mandate: must the fund follow an identified index, or can it make its own decisions?

Benchmark: replicated, comparative or absent

The word benchmark can play different roles.

Replicated index. It is the objective of the indexed fund. Performance is assessed through the gap to that index, taking into account costs, taxation and replication technique.

Comparative benchmark. It serves to judge an active fund or to represent its universe. The manager can depart from it, and the portfolio need not hold the same securities or weights.

Risk benchmark. It can define tracking-error limits, exposures or controls, without being replicated.

No explicit benchmark. Some strategies pursue an absolute return, an income or a risk objective. The absence of a replicated index does not prevent comparisons, but it requires stating which reference is used, and why.

Saying only “benchmark: MSCI World” therefore does not clarify the legal and operational relationship between fund and index. You need to know which role it plays.

Tracking difference, tracking error and Active Share

Three measures help describe different behaviours.

Tracking difference is the return difference between fund and index over a period. For a passive ETF it shows the economic result of replication after costs and frictions.

Tracking error measures the variability of the return gaps over time. A small average gap can coexist with wide oscillations; a stable negative average gap can produce a low tracking error.

Active Share measures how much the portfolio’s weights differ from the benchmark’s:

Active Share = ½ × sum of the absolute weight differences

The measure, introduced by Cremers and Petajisto, runs from 0% for a portfolio identical to the benchmark to 100% for one with no overlapping positions. It does not measure skill, probability of outperformance or overall risk. It also depends on the choice of benchmark.

A passive ETF on an alternative index can have a high Active Share against the broad market and zero against the index it replicates. The question “relative to which benchmark?” is not incidental: it determines what the number means.

Closet indexing: a category to be proven

Closet indexing is when a fund presented and priced as active stays very close to its benchmark. But the similarity cannot be inferred from a single photograph. You need at least:

• an appropriate benchmark;
• a time series of compositions or returns;
• Active Share and tracking error read together;
• the fund’s mandate and constraints;
• the fees charged and the length of the observation.

A portfolio temporarily close to the index can reflect an active choice or market conditions. The label is the conclusion of an inquiry, not a filter based on the name.

Active versus passive: the aggregate arithmetic

William Sharpe formulated a simple principle: before costs, the average return of all active investors must coincide with that of the passive market they jointly compose; after costs, the active average must be lower.

It is an aggregate identity, not proof that every active manager will lose to every index. Individual managers can outperform, some markets can be less efficient, and different benchmarks represent different sets. The investor’s problem is identifying, in advance, skill that persists after costs, taxes and turnover.

The chapter does not crown a universal winner. It explains that the active/passive choice changes:

• the source of the expected return;
• the dependence on the manager or on the methodology;
• the predictability of the exposures;
• cost and turnover;
• the risk of deviating from the benchmark;
• the criteria for judging the result.

Performance and persistence will be covered in the chapter on evaluation; costs in chapter 6.

How Rebalix classifies

Rebalix separates the classification of the management style from the product’s theme. For ETFs, the field shown to the reader follows a precise hierarchy:

• The issuer’s structured declaration, when available.
• The objective described in the KID: wording such as “actively managed” or “aims to outperform” indicates active management; formulas such as “passively managed” or “replicates the index” indicate passive management. If an active formula and a reference to replication coexist in the same document, the active declaration prevails.
• Exchange information, only if issuer and KID are silent. This possibility is provided for, but in the current snapshot it determines no displayed classification: all of them come from the issuer or the KID.

The commercial name does not feed the visible active/passive field. An internal sentinel does, however, intercept words such as “Active” or “Research Enhanced”, to prevent potentially active products from entering the index pages by mistake. It is a prudential guard, not a classification shown to the reader.

The theme — for example technology, clean energy, quality or cybersecurity — can be recognised from the name to power search and filters. It does not, however, prove whether the management is active or passive: a theme can be implemented by an index or by a discretionary manager.

Rebalix does not use returns, turnover, number of positions or similarity to the benchmark to “guess” the style. Those data describe behaviour; they do not replace the investment policy. The criterion is stated in the methodology.

If no source allows an ETF to be classified, the result remains undetermined: it is not turned into “passive” by default. ETCs, ETPs and ETNs without a declaration are instead treated by the engine as passive by structure, because they are not funds in which a manager discretionally selects securities. This technical convention does not turn them into passive ETFs, and the two groups must not be added together without distinguishing them.

The snapshot of 2 September 2026

The live Rebalix register holds 261 active classifications, 2,662 passive and 855 undetermined. The 2,923 determined classifications come exclusively from issuers and KIDs.

The public screener contains 3,063 instruments. Among the 2,972 fund ETFs, 261 are active, 2,645 passive and 66 undetermined. Alongside them sit 91 instruments treated as passive by structure: 60 ETPs and 31 ETCs. All 261 active ETFs in the register pass the minimum-fields gate and also appear in the screener.

These numbers describe the Rebalix perimeter at the stated date, not the entire European market.

Three cases that put the labels to the test

The three examples show why the axes must not be confused: “smart beta” does not imply active management, a systematic process can be active, and a theme can be implemented passively.

A checklist for reading the style

• Declaration: does the issuer define the fund as active, passive or indexed?
• Objective: does it replicate an identified index, or does it aim to beat it?
• Role of the benchmark: replicated, comparative or risk-related?
• Discretion: who can change securities and weights, and under what circumstances?
• Methodology: are the rules public, stable and replicable?
• Behaviour: are tracking difference, tracking error and Active Share consistent with the mandate?
• Costs: is the price charged consistent with the process offered?
• Name: does it really describe the style, or only the theme?

Eight mistakes to avoid

• “Passive means no decisions.” The decisions are embedded in the index and in the replication.
• “Active means frequent trading.” Discretion can also produce stable portfolios.
• “If it uses an algorithm, it is passive.” A proprietary model can manage actively.
• “If it has a benchmark, it is passive.” The benchmark can be merely comparative.
• “Smart beta is active management.” It is often passive replication of a non-traditional index.
• “High Active Share means a skilled manager.” It measures difference, not quality.
• “Thematic means active.” The same theme can be indexed or discretionary.
• “The fund’s name is enough.” Classification must start from the official documents.