In our previous article, “Active Edge | Unlocking the Big ‘Secret’ of Active ETFs with a Single Checklist,” we explored whether investors can simply copy the holdings of an active ETF. The conclusion was that while you can see part of the portfolio, you cannot replicate the manager's day-to-day judgments in response to market conditions. This raises a more fundamental question: what is the real difference in performance between active ETFs and passive ETFs? Both can be bought and sold during trading hours just like stocks, so why is one called “active” and the other “passive”? Today, we will clarify the distinction by focusing on a single key concept—the source of returns.

1. Standard ETFs Capture Beta, Active ETFs Aim for Alpha

First, the goal of a passive ETF is simple: track the index. Whatever is in the index, the ETF buys, and its rise and fall move in line with the benchmark. When you buy a CSI 300 ETF, for example, you earn the gains of the CSI 300—this is known as Beta return, which represents the market’s average performance. Second, the objective of an active ETF shifts: it strives to outperform the performance benchmark. Instead of passively replicating an index, the fund manager independently selects stocks across the entire market, flexibly adjusts sector allocations and individual stock weights, and aims to generate returns that beat the benchmark. That excess return is what we call Alpha. To use an analogy: a standard ETF is like riding a bus—the route is fixed, and your arrival time depends on traffic conditions. An active ETF is like driving your own car—you decide the route, and whether you can take shortcuts or avoid congestion depends on your judgment. In short, Beta is determined by road conditions, while Alpha is determined by driving skill.

2. The Source of Alpha: Stock Selection Freedom as the Core Distinction

The most fundamental difference between active and passive ETFs lies in the freedom of stock selection. On one hand, a passive ETF strictly tracks its index, and the manager can only allocate according to the index weights. Even an index-enhanced ETF can make minor adjustments relative to the underlying index, but it remains bound by the requirement that at least 80% of assets must be invested in index constituents and candidate constituents, effectively keeping it “tethered to the index.” On the other hand, an active ETF allows the fund manager to select stocks across the entire market based on their own strategy and research, without being limited to index constituents. This freedom makes the sources of Alpha more diversified. One key source is individual stock selection: through in-depth research, the manager identifies assets that the market has not yet fully priced, or assigns higher weights to high-quality companies. This is the most crucial driver of Alpha. Another source is sector and style allocation: the manager can actively overweight industries where the business cycle is improving, or adjust factor exposure ahead of a style rotation. A third source is portfolio construction and weight optimization: even when the same stocks are selected, differences in how much to buy, how little to buy, and when to rebalance can create meaningful return gaps. This ties back to the “portfolio puzzle” we discussed in the previous article.

3. The Other Side of Alpha: Discipline Constraints on Active ETFs

Some readers might wonder: with this much freedom in stock selection, could the fund manager just “run wild”? The answer is no. Regulators have paired the relaxation of stock-selection constraints with a clear disciplinary framework for active ETFs. According to the business guidelines of the Shanghai and Shenzhen stock exchanges, an active ETF must meet several key requirements: it must hold at least 30 stocks; the combined weight of its top ten holdings may not exceed 60% of the fund’s net asset value; the liquidity of the stocks held must meet certain standards; and turnover must be reasonably controlled to prevent excessive short-term trading. The significance of these rules is that the Alpha generated by an active ETF is achieved within a framework of diversification and discipline, not by concentrating bets on a single direction. The manager has the freedom to pick stocks, but not the freedom to stake the entire portfolio on just a few names. ETFs offer a more convenient investment structure, while active management provides the potential to pursue Alpha. The two are gradually converging.

Returning to the original question: what is the difference between active and passive ETFs? A passive ETF primarily earns market Beta, while an active ETF seeks to capture Alpha on top of Beta. For investors, this is not a question of “which is better,” but rather “what do you want in your portfolio?” If you are looking for average market returns, a standard ETF is efficient enough. If you value professional management and want the potential to outperform the benchmark, an active ETF offers a new option. Passive strategies track the market; active strategies hunt for opportunities. Different tools serve different needs. Active Edge opens up a new investment perspective!

Risk disclaimer: The views expressed here are for reference only, are subject to change with market conditions, and do not constitute any investment advice or commitment. The products mentioned are equity funds, which are securities investment funds with relatively high expected risk and expected returns. Their expected returns and expected risk levels are higher than those of hybrid funds, bond funds, and money market funds. Before purchasing any related fund product, please carefully read the fund’s Contract, Prospectus, and other legal documents, and choose a product that matches your risk tolerance. Funds carry risk; invest with caution.