Investing in Active VS Passive Mutual funds in India

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There has been a lot of debate to decide between the two mutual fund investing style – Active and Passive, which is a better one? 

The answer is active funds, but not all active funds perform better than the passive funds. Let’s try to understand these two types of mutual funds in India and learn how to select the active funds that might beat the returns of a benchmark index. 

What are Active Funds?

Active funds are mutual fund schemes in which the Portfolio Manager has the flexibility in choosing the investment portfolio within the broad parameters of the investment objective of the scheme. In other words, the Fund Manager will actively manage the funds by selecting the stocks of their choice.

Features of Active Funds:

  • Investors expect the Portfolio Managers to provide better than the benchmark index returns.
  • These funds have a higher expense ratio as compared to index funds in India.

What are Passive Funds/Index Funds?

On the other hand, Passive funds are mutual fund schemes in which the Portfolio Manager has no role or flexibility in choosing the investment portfolio. These mutual funds simply track and invest in the components of benchmark index. In other words, the Portfolio Manager does not have a role in selecting the stocks of their choice and simply track and invest the funds in the stocks that are listed on an underlying Index like Nifty 50 or Sensex, etc. Therefore, passive funds are also known as Index funds in India.

Features of Index Funds:

  • These funds give returns that are inline with the benchmark index.
  • They have a lower expense ratio as compared to active mutual funds in India.

While evaluating the top active funds for investing, it wouldn’t matter if active funds have a higher expense ratio as compared to index funds, if the post-expense returns delivered by them are higher than index funds in India. 

Comparing Performance of Active funds to Index funds in India:

You may see several articles on the internet that say 70-80% of actively managed mutual funds have not beaten the benchmark index returns in the last 1 year. However, this is not a fair representation of what is true and there are several reasons for it: 

  • Performance for any equity linked mutual funds are not to be measured in a shorter time frame of 1 year or even 3 years as these investments may see higher volatile in shorter time-frame and which is usually adjusted in the longer-time frame.
  • While comparing the long-term returns of a mutual funds the start date and end date for a specific time period which is not affected by the current market conditions is necessary. For example- a mutual fund scheme might have a 5-year return of 20-25% as on March 2021 but if returns were checked a year back when the market crashed due to COVID pandemic the same mutual fund returns might be 0 or even negative. 
  • There are over 2000 active mutual funds in India investing in nearly 40 different benchmark indices. Hence, even if 5% of the overall market performs, at least 100 mutual funds will outperform. An investor only needs 4-5 quality mutual funds out of these 100 options. 

Since not everyone may have the knowledge or expertise in selecting the best mutual funds in India for investing, consulting an AMFI Registered Mutual Fund Advisor is a good option. 

Below are some recommendations on top performing active mutual funds in India:

Scheme NameAUMTER1 Year Return%3 Years Return%5 Years Return%Inc. Return%
Invesco India Contra Fund (G)8,210.761.78%4.54%17.70%12.61%13.95%
UTI-Dividend Yield Fund (G)2,655.912.19%0.22%16.45%11.01%14.16%
ICICI Pru Long Term Equity Fund – (G)9,072.141.93%5.86%15.39%11.50%21.01%
HDFC Flexi Cap Fund – (G)26,511.451.75%14.58%16.09%11.31%21.56%
Mirae Asset Emerging Bluechip Fund (G)20,663.711.69%2.36%21.02%14.29%20.10%
HDFC Top 100 Fund (G)19,910.471.82%9.82%12.10%9.33%20.93%
Nippon India Growth Fund – (G)11,267.891.89%6.56%23.25%13.30%25.06%
ICICI Pru Multicap Fund – (G)6,156.911.98%3.38%14.63%10.60%19.65%
HDFC Capital Builder Value Fund – (G)4,781.712.06%4.31%14.16%9.03%20.20%

Below are some recommendations on top performing index funds in India:

Scheme NameAUMTER1 Year Return%3 Years Return%5 Years Return%Inc. Return%
UTI-Nifty 50 Index Fund (G)7,068.100.31%6.69%14.75%11.68%14.85%
HDFC Index Fund-Nifty 50 Plan5,940.600.40%6.53%14.48%11.47%14.41%
HDFC Index Fund – S&P BSE SENSEX Plan3,390.390.40%6.95%14.40%12.19%14.68%
ICICI Pru Nifty 50 Index Fund – Regular (G)3,065.530.41%6.53%14.48%11.16%14.63%
SBI Nifty Index Fund (G)2,416.930.50%6.44%14.13%11.08%14.04%
ICICI Pru Nifty Next 50 Index Fund (G)2,042.740.73%2.46%14.37%7.60%10.93%

Benefits of investing in active mutual funds in India:

  1. Higher upside potential: Portfolio Managers in an actively managed mutual fund through expert stock selection and regular portfolio churning can generate better returns than the benchmark index.
  2. Inefficiencies in the Index: Index is determined based on only the quantitative factors and not the qualitative factors. For example: Sensex comprises of 30 top companies in India based on the market capitalization, it does not take into consideration the qualitative factors like a company’s future growth prospect into account which can lead to inefficiencies. Example, Bajaj Auto was dropped in Dec 2021 after the stock price fell and since then the stock is up almost 35%. 
  3.  Large cap Index does not have any small and midcap companies listed which makes them miss the opportunity for greater returns. Past data show small and midcap companies have outperformed large cap stocks, but since these stocks have a higher risk as compared to large cap stocks generating returns through these stocks require experience and expertise which an active fund manager possess.

Why index funds in India should an individual invest in?

Index funds can be an ideal way of investing for assets like gold or to get an exposure of global indices where opportunities are limited. Investing in Index funds can also be done to capture short term gains from the volatility in the stock market.

It is important you consult your financial adviser to ascertain which style of investing is suitable for your risk profile, goals and investment needs.