Active Vs. Passive Funds: How Their Three-Year Returns Compare

Professionally-managed active mutual funds aim to outperform the market, whereas passive funds track specific market indexes and are of low-cost because of minimal fund management
Active Vs. Passive Funds: How Their Three-Year Returns Compare

When investing in mutual funds, investors have two main options: active and passive mutual funds. Before making an investment decision, evaluating the fund’s performance, fees, and expenses is hence essential.

Active mutual funds are managed by a professional fund manager who actively selects and manages the assets in the portfolio to outperform a benchmark index or generate higher returns than the market. These fund managers use various investment strategies to identify the best investment opportunities.

Passive funds, on the other hand, allow investors to look for returns with minimal risk. Passive funds, such as index funds, are designed to track the performance of a specific market index, like the Nifty 50 or the Nifty 500, by investing in the same securities that make up the index. As a result, they have lower management fees than active funds as they need less active management. In the case of active funds, returns may erode over time due to higher costs and expenses.

Comparing Returns

However, when comparing returns, the fund category is critical for comparison. Farooq Nabi, director at Anand Rathi Wealth Management, explains, "Active and passive funds should be compared within the same category. For example, an equity fund index, such as the Nifty 50 index fund, should be compared with a large-cap equity mutual fund. There may be slight deviations from a proper comparison if index funds are compared with actively managed multi-asset or large and mid-cap funds."

Regarding returns, Nabi says, "While passive funds have been found to outperform active funds in mature economies such as the UK, the US, and Singapore, the situation in India is different. As a developing economy, India gives more room for active fund managers to outperform the benchmark. Historically, top fund managers in India have delivered an alpha of 1 to 2 per cent above the benchmark."

Ultimately it is one's investment philosophy helps you decide between active and passive mutual funds. But investors should consider their individual financial goals and risk tolerance.

In this article, we will compare index funds and large-cap funds. Index funds are selected because it is the only passive fund type, other than exchange-traded funds, bought or sold during market hours, much like stocks that call for more active involvement.

On the other hand, large-cap funds invest in stocks of companies with large market capitalisation. It requires more active fund management as its portfolio is entirely equities. Data

has been collected from a mutual fund direct plan rather than the regular scheme, as the former does not pay distributor commissions, thus cutting costs and improving returns.

When we ran the data, the average category return of passive funds tracking Nifty 50 showed slightly better returns than their active counterparts for most fund houses.

In the case of large-cap funds, the top 28 large-cap funds have an average 3-year return of 23.72 per cent. But the average return from a passive fund tracking Nifty stands at 25.18. So fund managers were not able to create an alpha over the benchmark.

When taking individual index fund performances, UTI Nifty 50 Index Fund returned 25.42 per cent, while HDFC Index Fund-NIFTY 50 gave 23.36 per cent. Among the Active large-cap funds, eight funds beat the returns from the passive category topper UTI Nifty 50 Index Fund. Nippon India Large Cap Fund is at the number one position with 30.87 per cent. Next in the winner's list are HDFC Top 100 Fund, SBI Bluechip, ICICI Bluechip, and Kotak Bluechip (Three of them are part of OLM50, a hand-picked list of Outlook Money's recommended list).

Accordingly, some active fund managers, on average, were able to beat index funds with a good margin. Therefore, you may consider passive funds if you are looking for a fund with low costs and want to achieve market returns without taking on too much risk, but if you seek market-beating returns, you may choose to invest in active funds. So selection of the right fund is crucial.

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