Which Mutual funds to invest either Active or passive

 Will you put your money in an actively-managed equity fund or prefer to plough it in passively-managed index funds. But then what’s the difference, you may ask? Here’s a major one. While an index fund puts your money into the benchmark index — Sensex or Nifty, a diversified fund will invest in the broader market.

Index funds are likely to deliver returns in line with the benchmark indices and are, therefore, preferred by dynamic investors during volatile times, such as the present.

Passively-managed funds do not try to beat the index, but simply aim to track it by investing in companies in accordance with the constituents of an index. The managers of the fund have far lower expenses, and the charges to investors are lower than for active funds.

While investing in passive mutual funds, or index funds, investors should not choose just any fund. Not all passively-managed funds in India fail to deliver returns in line with the benchmarks.

An ETIG study since the beginning of the bull run showcases that almost half the passively-managed funds underperformed the benchmarks by a margin larger than acceptable. A little deviation is okay. But more than, say 1-2% per annum is too much. Some of this underperformance could be due to expense ratios, which are 1% to 1.5%.

This is too large compared to international trends. In the US, passive funds charge around 0.5%. This is fair, since passive funds do not require any active fund management. So, there is no reason they should charge high fees, which are not too different from active funds.

Blame that on the tracking errors. To that, add loads and you make a little less than 12%, on an average, of what the benchmarks deliver. On the other hand, pick the right active fund and you could rake in the moolah.

Take, for instance, Reliance Growth. If you invested Rs 10,000 in April ’03, just when the bull run started, it will now be a staggering Rs 78,338 as in October end. In comparison, the Sensex has gone up by only 3.2 times and your Rs 10,000 will currently be Rs 32,274.

Over varied periods of times, diversified funds have outperformed, though outperformance seems to have declined in these volatile times. In the West, where markets are mature, it’s seen that outperformance by actively-managed diversified mutual funds is minimal.

Most of these actively-managed funds actually underperform too. But in India, it’s seen that actively-managed funds always outperform the benchmarks by huge margins.

Many sectoral funds or small- and mid-cap funds, which may outperform during a bull phase, may start showcasing negative returns in volatile times when the sector starts underperforming. These may be high-risk high-gain funds. Therefore, an actively-managed diversified fund is perhaps the best bet for a lay investor.

The difference is huge when you look at returns from passive funds and the actively-managed ones. So what do you do? For those investors who want a product that closely mirrors a major index, such as the Nifty or the Sensex, going for a passive fund is probably the wisest move.

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