Mutual Funds: Why passive funds can be a great choice for retail investors to invest in 2025?

If you are planning to invest in mutual funds this year, one of the dilemmas you may face is choosing between active and passive mutual funds.

With the benchmark index facing extreme volatility and having lost nearly 10 per cent off its peak, the scope of growth seems promising in this segment. It's a different matter that some of the losses have already been pared, with Nifty50 rising by nearly 2 per cent on the second session of 2025, i.e., on Thursday. 

Moreover, Sebi has rolled out the mutual fund lite framework, following which index funds are likely to get a shot in the arm.

The latest guidelines underscore uniform guidelines for launching equity passive schemes. With the entry barrier for launching index mutual funds kept lower for passive schemes under this framework, retail investors are expected to find these schemes far more lucrative and tempting.

“The Sebi's Lite framework provides a good opportunity for investors to invest in passive funds. They have brought in uniformity in regulations for passive schemes, it is quite a welcoming move for the first time investors,” says Sridharan S., a Sebi-registered investment advisor and founder of Wealth Ladder Direct.

What are passive schemes?

For the unversed, passive schemes refer to mutual funds that invest in the stocks in a pre-defined ratio and in accordance with pre-defined criteria, which is the same as that of a benchmark index.

For instance, a passive scheme that tracks the Nifty 100 index will invest in the same stocks and in the same proportion as Nifty 100 does.

As a result, the performance delivered by the mutual fund is the same as that of index, albeit subject to some tracking error.

This means that, unlike active funds—which may fail to beat the benchmark returns—passive funds give far more predictable returns.

Over three quarters of active equity large cap funds (77 per cent) underperformed the benchmark, as per the SPIVA India Focus report - is a case in point. In case of mid/small cap category, 52 percent of active funds underperformed in H1 2024.  

Why should you invest in index funds?

There are 270 index funds with total assets under management (AUMs) of ₹2.73 lakh crore and 214 ETFs with total AUMs of ₹7.85 lakh crore, shows the AMFI (Association of Mutual Funds in India) data as on Nov 30, 2024.

Passive mutual funds enable investors to earn the returns along the lines of a benchmark index such as Nifty 50. 

For instance, if someone had invested on January 1 last year in a passive fund which tracks Nifty50 then by the end of 2024, that scheme would have delivered the same return as that of Nifty 50 i.e., nearly 8.8 per cent return.

Likewise, if you are tempted by a particlar sector, say IT, then you could opt for a scheme that tracks Nifty IT index. Else, if you want an exposure to mid cap stocks, you could simply invest in a passive fund that tracks Nifty mid cap 100 or BSE mid cap index. 

Sounds simple? Isn't it?

Alternatively, if you opt for an active mutual fund, you are expected to exercise due caution and check the past returns of that scheme, besides the performance delivered by the fund managers who manage that scheme. All these considerations are rendered insignificant in passive schemes. 

This is because the returns given by the schemes across fund houses and fund managers would be the same (subject to tracking error) as long as the benchmark index is the same.  

It makes the investing decision of investor simpler since s/he doesn't need to keep track of different fund houses and their performance with regards to different schemes.

Given a high concentration of index funds that are expected to deliver returns on predictable lines, investors find these schemes quite tempting and investible.

“As more and more investors understand that generating alpha for a longer period from active mutual funds is not easy, they are more interested in passive mutual funds, which are very cost-effective and a no-brainer for the investors,” says Preeti Zende, founder of Apna Dhan Financial Services.