Investing in U.S. Equity Funds: A Comprehensive Analysis of Active and Passive Strategies

TL;DR: U.S. stock funds fall into two broad categories: active and passive. Passive funds generally charge lower fees and track index performance, while active funds are managed by fund managers who select stocks and typically charge higher fees. According to S&P Dow Jones Indices’ SPIVA reports, over the long term most active funds have not consistently outperformed their benchmark indices. The right choice depends on your investment goals and risk tolerance.

U.S. stock funds are a common starting point for Hong Kong investors. When choosing between active and passive funds, many people feel unsure. This article objectively outlines the differences between the two strategies to help you build a clearer understanding before making any investment decisions. Any investment decision should be evaluated comprehensively in light of your personal financial situation and risk tolerance.

What Are U.S. Stock Funds?

U.S. stock funds broadly refer to pooled investment vehicles that invest in shares of U.S.-listed companies, allowing investors to hold a basket of U.S. stocks without having to buy individual stocks directly. U.S. stock funds generally fall into two main categories:

• Active Funds: Stock selection is led by professional fund managers, with the goal of seeking returns that outperform the relevant benchmark index.
• Passive Funds: These track a specific index, such as the S&P 500, with the goal of closely matching that index’s performance.

Exchange-traded funds (ETFs) are the most common form of passive fund. They are listed and traded on exchanges, and they operate much like stocks. If you would like to learn the basics of fund investing, you can refer to Longbridge Academy’s beginner guide to fund investing.

Main Differences Between Active and Passive U.S. Stock Funds

Management Style

Active funds are managed by fund management teams that continuously monitor the market, analyze corporate performance, and actively adjust their portfolios. Passive funds, by contrast, hold positions according to the weights of index constituents, without discretionary stock picking, and generally offer relatively higher transparency.

Fee Structure

Fees are one of the most significant differences between the two types of funds. Because active funds involve active management, their annual management fees are generally higher than those of passive funds that track an index. Passive ETFs typically have relatively lower annual expense ratios. Actual fees vary by fund, and investors should rely on each fund’s official documents.

Tip: The impact of fee differences on returns over the long term should not be overlooked. Here is a hypothetical example: if two funds generate the same average annual gross return, but their annual fees differ by 1.5%, then over a longer investment period, that fee gap could have a substantial effect on the final value of accumulated assets. (This example is for illustration only and does not constitute investment advice.)

Holdings Transparency

Passive ETFs usually disclose their holdings daily. Active funds disclose holdings less frequently, generally on a quarterly basis, and some funds provide only limited portfolio details in order to protect their investment strategy.

Characteristics of Active Funds

The core proposition of active funds is that, through professional management, they seek to outperform a benchmark index under certain market conditions and can concentrate investments in specific themes, such as technology or healthcare.

On the other hand, according to SPIVA reports published by S&P Dow Jones Indices, over the long term most active funds have not consistently outperformed their corresponding benchmark indices. Investors may assess a fund’s track record, fees, and management philosophy. (Source: SPIVA U.S. Scorecard)

Characteristics of Passive Funds

Passive index ETFs diversify away single-stock concentration risk by tracking an index. They generally have lower fees and relatively higher transparency, and ETFs that track broad indices allow investors to gain exposure to hundreds of U.S.-listed companies at once. It is important to note that diversified holdings do not mean low risk. When the relevant index falls, passive funds will experience the same decline.

According to LSEG Lipper data, as of the end of December 2023, global passive equity funds had net assets of about US$15.1 trillion, surpassing active funds’ US$14.3 trillion for the first time. (Source: LSEG Lipper / Reuters)

You can visit Longbridge Market Data to track the performance of major U.S. stock indices.

Practical Considerations for Hong Kong Investors

For Hong Kong investors, investing in U.S. stock funds also involves the following practical considerations.

Dividend withholding tax: Under U.S. Internal Revenue Service (IRS) rules, dividends received from U.S. stocks by non-U.S. residents are generally subject to 30% withholding tax. This tax may apply whether you hold active or passive funds. (Source: IRS NRA Withholding)

Exchange-rate risk: U.S. stock funds are denominated in U.S. dollars, so investors must bear the risk of exchange-rate fluctuations between the Hong Kong dollar and the U.S. dollar.

Investment threshold: Active funds generally have minimum investment amount requirements, while passive ETFs can be bought one share at a time, making the entry threshold relatively more flexible. If you would like to learn the basics of U.S. stock investing, you may refer to Longbridge’s introductory article on U.S. stock investing.

How to Evaluate the Two Types of U.S. Stock Funds

There is no single right answer when choosing between active and passive U.S. stock funds. You may use the following questions as an initial framework for evaluation:

• Investment objective: Is your goal to closely match the overall market’s performance, or do you want the fund manager to pursue excess returns?
• Fee sensitivity: The long-term cumulative effect of fee differences deserves serious consideration.
• Holdings transparency: Passive ETFs typically offer higher holdings transparency.
• Investment horizon: The longer the investment period, the more significant the impact of fee differences on accumulated assets.

If you would like to learn about the types of investment products offered by Longbridge, you may refer to the relevant product pages.

Frequently Asked Questions

What is the difference between U.S. stock funds and directly buying and selling U.S. stocks?

Directly buying and selling U.S. stocks requires you to pick stocks yourself, which means higher single-stock concentration risk. U.S. stock funds diversify holdings through pooled investment, so there is no need to research each stock one by one, but the funds themselves also involve fees and their own risk characteristics. Each approach has its own features, and there is no single option that suits all investors.

Does a passive ETF mean lower risk?

Passive ETFs diversify away concentration risk in individual stocks, but they still bear the overall market risk of the index. When the market falls sharply, passive ETFs will decline as well. Diversification is not the same as low risk. All investments involve risk, and past performance does not represent future results.

Can active funds consistently outperform an index?

According to S&P Dow Jones Indices’ SPIVA reports, over the long term most active funds have not consistently outperformed their benchmark indices, although individual funds may perform differently under specific market conditions. Investors should review long-term track records and fees rather than making judgments based solely on short-term performance.

How can Hong Kong investors buy and sell U.S. ETFs?

Hong Kong investors can open an account with a licensed securities broker to buy and sell ETFs listed on U.S. exchanges. Longbridge Securities offers U.S. ETF trading services. For more details, please refer to the Longbridge support page.

Conclusion

U.S. stock funds give Hong Kong investors a way to access the U.S. stock market. Active and passive funds each have different fee structures and risk characteristics. Passive index ETFs generally have lower fees and relatively higher transparency, while active funds generally have higher fees, and their long-term performance varies from fund to fund.

Which option to choose depends on your investment goals, risk tolerance, and level of experience. Whichever you choose, you should fully understand how it works, its risk characteristics, and its trading rules, and establish a clear risk management plan. You can learn more about investing through Longbridge Academy or by downloading the Longbridge App.