Active vs passive ETFs: the pros and cons

Exchange-Traded Funds (ETFs) have become one of the most popular ways to invest. An ETF is a fund that can be bought and sold on a stock exchange and typically holds a basket of investments, such as shares or bonds. They offer investors an easy way to add diversification to a portfolio through a single investment.

Broadly speaking, ETFs fall into two categories: passive – also known as index tracking – and active.

What are passive ETFs?

A passive ETF aims to track the performance of a market index, such as the FTSE 100 or S&P 500, rather than trying to beat it. Depending on how the ETF is structured, it may hold all the investments in the index, a representative selection or use derivatives to replicate its performance.

Passive ETFs have become popular because they are typically low-cost, transparent and easy to trade. By investing in hundreds, or even thousands, of securities, broad-market passive ETFs can provide instant diversification and reduce the risks associated with holding individual shares.

For example, a UK investor might choose an S&P 500 ETF to gain exposure to some of the largest companies in the US. Similarly, someone looking to reduce portfolio volatility may use a passive bond ETF, which tracks a broad index of government and corporate bonds.

There are also thematic passive ETFs that track specialist indices focused on long-term trends such as artificial intelligence, cybersecurity or clean energy. 

Pros and cons of passive ETFs

The biggest attraction of passive ETFs is their simplicity and low cost. Rather than trying to identify the best-performing stocks or sectors, investors can gain exposure to an entire market and participate in its long-term economic growth.

The main drawback is that passive ETFs follow the market wherever it goes. If markets fall, then the passive ETF tracking that market falls too. They also can’t avoid sectors or companies that may appear overvalued or face deteriorating prospects.

This is particularly relevant today, when some major stock market indices are heavily concentrated in a small number of large technology companies. If those companies were to disappoint investors, passive ETFs could be disproportionately affected.

There are also equal-weighted ETFs, where each constituent of an index is allocated the same share of the portfolio, helping to reduce concentration risk that can arise – for example when a small number of mega-cap stocks dominate an index.

While equal-weighted ETFs can help reduce concentration risk, they do not protect against broader market declines and can still fall in value when the overall market falls.

What are active ETFs?

Active ETFs take a different approach. Rather than tracking an index, they are managed by investment professionals who decide which securities to buy and sell in an attempt to outperform a benchmark or achieve a specific investment objective.

While active ETFs have traditionally represented a small share of the ETF market, they are becoming increasingly popular. In Europe, active ETF assets reached €85.6 billion at the end of the first quarter of 2026, up from €52.5 billion at the end of 2024 and €78.8 billion at the end of 2025, according to Morningstar data. 

Despite this rapid growth, active ETFs still account for only around 3.4% of the European-domiciled ETF market, compared with approximately 12% in the US.

Pros and cons of active ETFs

The key advantage of an active ETF is flexibility. Fund managers can adjust portfolios as market conditions change, seek out investment opportunities and manage risks in ways that a passive index-tracking ETF can’t.

For example, if inflation remains persistent and interest rates are uncertain, an active bond manager can adjust the portfolio's exposure to different types of bonds. Similarly, an active equity manager might choose to reduce exposure to expensive technology stocks and increase holdings in areas they believe offer better value, for example.

The trade-off is that active ETFs generally charge higher fees. There is also no guarantee that a manager's decisions will outperform the market. Investors are paying for expertise, but success is never certain.

Which is right for you?

Neither active nor passive ETFs are inherently better. Passive ETFs offer low costs, broad diversification and transparency. Active ETFs offer flexibility and the potential to outperform, but at a higher cost and with greater reliance on a manager's judgement.

Ultimately, the right choice depends on your objectives, time horizon and risk tolerance. For many investors, a combination of active and passive ETFs can provide the best of both worlds: low-cost market exposure alongside targeted opportunities where active management may add value.

Investors can also diversify in other ways, such as spreading investments across different asset classes, regions, sectors and investment styles, rather than relying solely on the choice between active and passive ETFs.

Tips from our Head of ETF and Index Solutions: 7 things to consider

Lynn Hutchinson, Head of ETF and Index Solutions, says: “When choosing an ETF, it can be tempting to focus solely on the annual fee. However, cost is only one factor to consider. An ETF, as with any fund or investment, should provide the market exposure you're looking for, track its index as effectively as possible, be cost-effective to own and trade, and come from a reputable provider. Looking at the overall picture – not just the headline charge (OCF) – can help you make more informed investment decisions.”

When comparing ETFs, she suggests considering:

• What it invests in – does it provide the exposure you want? Don’t just look at the name of the product but look at the product provider’s website, which can help an investor identify exactly what they are buying and the underlying exposure.
• How well it tracks its index – has it consistently followed its benchmark?
• The total cost of ownership – consider ongoing charges figure (OCF), trading costs and bid-offer spreads (buy and sell), not just the annual fee.
• Liquidity – is it easy to buy and sell at a fair price?
• The provider – does it have a strong reputation, experience and transparent reporting?
• How it works – does it physically hold the investments or use derivatives, and do you understand the approach?
• Size and longevity – well-established ETFs with sufficient assets may have a lower risk of closure and can provide greater confidence for long-term investors.