Mutual Funds have also been a great tool of investment for both inexperienced and experienced investors. The skill and competence of the fund managers help investors to take advantage and gain the best possible returns.
There are various mutual funds operating in the industry and each MF offers a number of schemes which allows an investor to choose from based on his return expectation and desired level of risk.
In this article, we differentiate between two types of categories of Mutual Funds; active funds and passive funds.
The primary difference between these two funds is based on the management of such funds. Let us start by understanding the funds in great detail.
Active Funds
Active Fund can be understood as any other equity, debt or hybrid fund in the market where a professionally skilled Mutual Fund manager uses the pool of funds received from various investors and based on the choice of scheme selected by the investors, selects a group of companies to invest in, make an informed decision about how much investment is to be made in what ratio amongst the previously selected companies. He keeps track of the price changes happening in the portfolio and based on such price fluctuations he may decide to dilute, increase or change the concentration of his investments in order to get the best results for his/her clients.
Passive Funds
Looking at the above explanation for actively managed funds, we feel that is all there is to Mutual Funds, as when we invest our money in a Mutual Fund scheme, we expect the fund to use our money wisely and monitor our investments continuously on our behalf, so that we don’t have to.
However, that is not always the case; passively managed funds or passive funds are an easier way in which Mutual Fund invests our money. Simply speaking, the Mutual Fund invests the money in a manner that the returns replicate the market gains/losses. One of the few examples of this could be the Index Funds. These funds comprise of companies that are part of the Nifty 50 or Sensex 30 index and the funds invests money in these companies only and that too in the same concentration as that of their market capitalization which makes the index. This way, the funds deliver an exact replica of the return made by the market over a period of time.
Difference between Active and Passive Funds
From the above, it can be clearly inferred, that the primary difference between the two funds is based on the management and selection of stocks.
Active funds can be said to be ones where the fund manager plays a highly important role as he is responsible for selection of stocks, amount to be invested, when to enter and when to exit, whereas passive funds are much simpler and don’t involve much effort from the fund managers.
The lack of effort from fund managers led to a lower expense ratio for passive funds as compared to active funds.
Active Funds are aimed at delivering a return percentage which is greater than the benchmark market return. Since passive funds follow the market rigorously, the returns made by such funds image the market growth over that period. Therefore, it becomes highly important for fund managers to ensure that active funds deliver over and above the benchmark market return because if not, then investors will not be willing to go for such funds, as they can get benchmark return at a lower cost.
Active or Passive Fund-What should an investor choose?
The million-dollar question that always remain unanswered for an investor is what should be chosen. The reason that this remains a mystery is because there is no correct answer in a way that there is no wrong answer either.
The choice of the fund would clearly be independent for every investor based on factors such as his expectations of returns and his risk appetite.
In case of an investor that is clearly wanting to gain as much as possible from the market and is ready to take a higher risk on his investments, actively managed funds may be the right way to go.
On the other hand, someone who likes to take a conservative approach may not be comfortable enough to risk a lot. In such cases, since the investor is not willing to take a higher risk and if he feels comfortable with a benchmark market return, passive funds are the right thing in the market. This may help them sleep comfortably at night; although nothing is a guarantee when it comes to capital market investments.
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