Active funds beating index funds mainly depend on the category of funds. Here when we analysed four categories, two active fund category beat their passive variants.
Active mutual funds aim to outperform their benchmark indices through active stock picking and thus have an active portfolio management strategy. Active funds allow more flexibility in-stock selection to managers, enabling them to capitalise on market opportunities and also actively manage risk. They can actively analyse which stocks are overvalued, whereas index funds only invest in the same weightage as followed by their benchmarks.
But these benefits higher, come with higher management fees compared to index funds.
Index funds passively track benchmark indices, such as NIFTY 500 or a specific theme-based index like Nifty Next 50. They aim to replicate these benchmark index performances rather than outperforming them. Fund managers only try to minimise tracking errors and thus closely match index performance. Investors gain exposure to an entire basket of stocks, as active fund managers are not selecting individual companies. Index funds thus offer diversification and also lower costs because of the lack of active fund manager participation.
But they don't offer sufficient protection against market downturns. Some stocks might be over-concentrated in some benchmark indices. And if there is a downturn in any of such stocks, the index will continue to maintain the same weightage and investors will have to suffer the losses. Index funds rely primarily on market wisdom and there is no one to analyse stock fundamentals.
When we compared large caps, small caps, mid-caps and flexi caps, the first two categories saw their active funds outperforming their benchmarks.
Out of 27 large-cap funds, 15 funds have surpassed their benchmark indices, in three years. Hence, if investors had opted for passive investment options such as index funds, their returns might not have been as favourable as the active funds. Out of 22 small-cap funds, 14 outperformed their benchmarks in three years.
But in midcap funds, if we take the 3-year returns 16 midcap funds out of a total 24 funds have underperformed their benchmarks. So investors would be more likely to get better returns if they invested in a midcap index fund. Only 11 flexi cap active funds have outperformed their benchmark in the same tenure out of the universe of 24 such funds.
