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Mutual funds: Confused between active and passive funds? Here is your answer
- Mutual funds: Actively managed funds aim to outperform their benchmark index, while passive funds seek to replicate the performance of a specific index
Making an investment choice can sometimes be a tricky task for investors. There is a plethora of investment options available in the market which further confuses the investors. When it comes to investing in mutual funds, people get confused as to whether they invest in an active or a passive fund. Proponents of both active and passive will have their arguments to attract investors, but experts suggest having an allocation in both funds.
Mutual funds: Active and passive funds
To, put it simply actively managed funds aim to outperform their benchmark index by leveraging the expertise of professional fund managers, while passive funds seek to replicate the performance of a specific index.
Performance of actively managed mutual funds vs passive funds
Vivek Sharma, Director (Strategy) and Head of Investments at Gulaq, the retail advisory arm of Estee Advisors said that the two things required by investors of active funds are – patience and conviction.
“We know that most of the active funds underperform the markets. But then there are few funds, which have done a phenomenal job like PPFAS,” added Vivek Sharma.
1)Performance comparison
According to Sonam Srivastava, Founder & CEO, of Wright Research, some studies have shown that over the long term, passive funds tend to outperform a majority of actively managed funds, largely due to their lower fees and reduced portfolio turnover. However, there are instances where skilled active managers can consistently beat the market.
2) Cost structure
Passive funds tend to have lower expense ratios compared to actively managed funds. This is because they require less research, trading, and management, resulting in lower costs.
“Over time, these cost savings can compound and make a significant difference in an investor's total returns,” said Sonam.
3) Diversification and risk management
While both active and passive funds offer diversification, their approaches to risk management can differ. As per Sonam Srivastava, actively managed funds may take more concentrated positions in specific stocks or sectors to generate alpha, which can introduce additional risk. Passive funds, on the other hand, typically maintain broad exposure to the entire market or index, leading to lower levels of risk.
4) Market conditions
The relative performance of active and passive funds can be influenced by market conditions. In periods of high market volatility or when stock correlations are low, active managers may have more opportunities to add value through stock selection and tactical asset allocation. Conversely, during periods of low volatility or high correlations, passive funds may outperform due to their low costs and broad exposure.
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First Published:18 May 2023, 12:50 PM IST
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