Several studies have been conducted, more in the Western world, over the last several decades to find out if passive funds perform better than active funds.
The raging debate between Active Vs Passive Funds has been going on for a long time in the world of investments. Let’s understand how these funds are different and which one is better for your portfolio.
Active Funds: These are funds that are managed by a fund manager. The fund manager invests by studying the market and the economy.
Passive Funds: These funds track a benchmark index. So, the returns of the index are translated into the returns.
Which one is better for your portfolio?
Several studies have been conducted, more in the western world, over the last several decades to find out if passive funds perform better than active funds. Usually, one full cycle, comprising of bull and bear phase, should be considered for drawing any meaningful conclusion.
According to Gaurav Goel, SEBI-registered investment advisor, it has been generally observed that in an environment where interest rates are going down, these low volatility funds or passive funds tend to perform better than other funds.
“However, in a rising interest rate environment, active funds generally tend to perform better. Index funds (passive) have lower expense ratios and hence over a period of time this differential compounding gives reasonably higher returns, other things remaining the same. Close to 85 per cent of fund managers underperform the Index funds in the United States,” Goel added.
“On an aggregate basis, even in Indian context, the above statistics appears true. However, the answer to this question lies in the ability of an investor to identify a good fund manager or “catch the remaining 15 per cent,” he added.
In the Indian context, we have a decent number of such fund managers who have consistently outperformed Index fund returns over long periods of time. It should be noted that Indian markets are not as mature as US markets. The size of the mutual industry in India is much smaller. The expense ratios of passive funds are very high compared to western world, even if it is lesser than the active funds.
Let’s understand this with an example
Consider two investors, A and B. Both of them invest in equity markets via mutual funds. A is an avid businessman with no spare time for tracking his investments. His banker has told him about a few mutual funds in which he invests regularly without really bothering about the outperformance of the funds. He cares only about the amount by which his investments are growing. On the other hand, B, who is a consultant in the financial industry, carefully analyses each fund he invests in. He tracks the performance, attends fund managers’ calls, researches the fundamentals and allocates his investments amongst the top fund managers of the leading asset management companies.
“It is obvious that A needs to opt more for a passive fund management strategy whereas B should opt for active funds. In a nutshell, if you can identify good fund manager then go for actively managed funds else stick with ease of Index funds,” he concluded.
