Armchair investor? Go for passive funds

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Looking to invest in mutual funds, but don’t know where to start? Don’t get caught up in the whole active vs passive fund debate. While experts suggest starting off with passive funds, how have they fared in terms of returns? We break it all down for you.

In an active fund, the manager is deeply involved in the daily operations of the fund. They are dynamic, regular buyers/sellers of the underlying asset of the funds, depending on market conditions. Here, the frequency of regular decision making and asset churning is high, since the manager decides what is added to the fund’s AUM (assets under management) and what is removed.

Away from action Passive funds, on the other hand, are mirrors. These funds simply imitate the performance of their underlying market indices. And an index is nothing but a collection of stocks that denote a common sector or parameter.

For instance, you want to know about India’s 50 biggest companies by market capitalisation. The NSE Nifty index represents just that. Want to know the biggest 500 companies in the US? The S&P 500 is just for that.

So, in essence, a passive fund allows you to invest in these companies, without having to constantly look out for them. So, are passive funds a good choice to start long-term investing? Both data and experts seem to think so.

No wild swings According to Nema Chhaya Buch, a Pune-based financial planner, “When the market is favourable, active funds generate positive alpha but when it is not the case, it can seriously lag in reference to its benchmark index and even generate negative alpha. But in passive investing, such wide swings in excess of market movements can be avoided. For long-term investing, passive funds make most sense.

“In the last 10 years, BSE Sensex has generated 13% returns on average. So, passive funds with underlying Sensex would generate returns at par. But the same cannot be said for active funds since it is largely a function of the fund manager’s strategies and skills. Thus, if the priority is a long-term investment, low fees, and staying invested in equity markets with lower risk, then passive funds make sense”, she continued.

How are passive funds doing?

As per recent AMFI data, Index funds raked in Rs 39,285.76 crore between January-March 2023. Last month, index funds saw inflows worth Rs 147.37 crores. Per ICRA research this year, between 2017-2022, only 8% of actively managed large cap funds were able to outperform the index’s benchmark.

By its very design, a passive fund generates returns equivalent to benchmark returns.