As the name implies, passive management (commonly referred to as indexing) is an investing strategy that doesn’t rely on active exposure. Instead, it tries to replicate a market index, such as the S&P 500 or the Dow Jones Industrial Average (DJIA).
Essentially, the idea behind passive management is that it’s very unlikely that humans can consistently outperform the market, so they should rather “go along with it,” passively. This idea resonates with the efficient-market hypothesis (EMH), that implies that current market prices already reflect all information available and that humans can’t beat the market in the long-term.
So unlike active portfolio management, passive investing doesn’t depend on subjective human decisions because there are no attempts to profit from market inefficiencies. Hence, passive management doesn’t rely on a select group of assets. Instead, the fund manager tries to track a market index.
The main advantages of passive portfolio management are related to its lower fees and operational costs, as well as reduced risks. Typically, a passive investment strategy will build a long-term portfolio that tracks the performance of a stock market index. Investment funds that apply such a strategy are usually associated with mutual and exchange-traded funds (ETF).
Therefore, the success rate of such an approach is dependent on much broader market performance, which is represented by a specific index. Essentially, this means that passive management is free from human error in regards to the selection of assets.
Historically, passive portfolio management strategies performed much better than active investing, mainly because of their lower fees. There was a growing interest in passive investing in the last decades, especially after the 2008 financial crisis.