Active MFs and Passive MFs
It is noteworthy that diversified equity funds following an active investment strategy are in a constant search to provide promising investment opportunities across various sectors to generate superior returns against their respective benchmark indices. The fund managers along with research professionals take active participation in discovering stocks which can create value for investors in the long run by controlling the overall risk on their total portfolio. While there's a risk involved if the fund manager makes a bad choice or follows an unsound theory of investing; the same can be controlled if one selects funds which follow strong systematic investments process and systems and viewing the funds past performance (returns).
If the fund manager engages in aggressive portfolio changing to boost returns, the level of risk which one is exposed to can be also be increased. While some actively managed funds do show high confidence towards the stock bets taken by them, a high expense ratio incurred by the fund not only increases risk but also leads to high cost for investors.
Hence, while investing actively managed funds one needs to aware of their attributes, and in case if you are not willing to take very high risk and are merely interested in replicating the broader benchmark indices; then the answer is passive funds which are nothing but Index funds.
This section will explain the difference between Active MF and passive MF.
Active funds are nothing but equity diversified mutual funds.
For investors' who are new to stock markets or even to the strategy of active investment management, but are willing to take risk for investing in the stock markets, could opt for equity mutual funds as they offer the benefits of diversification and professional management through skilled research professionals and a fund manager appointed by the mutual fund house. However while investing in mutual funds, you need to be careful and select appropriate ones which suit your ability to bear risk as well, in their attempt to outperform their respective benchmark indices and generate superior returns for you.
Passively managed funds
The mutual funds which invest in index stocks are called as Passive funds. The stocks which are part of index are called as index stocks.
Passively managed funds are aligned to a particular benchmark index such as the S&P CNX Nifty (Nifty), BSE Sensex, S&P CNX 500 or even for that matter a sectoral index such as BSE Bankex. The endeavour of these funds is to mirror the performance of the designated benchmark index, by investing only in the stocks of the index with the corresponding allocation or weightage. Hence, investing in passively managed funds is less burdensome as compared to investing in actively managed funds. Also they carry with them a low expense ratio along with a low risk (as compared to actively managed mutual funds), make market timing immaterial and low portfolio changing are also their advantages. The fund manager in an index fund exits a certain stock only when a respective stock exits from the index and is replaced by another one.
However despite the inherent benefits, passive managed mutual funds (index funds) have not caught retail investors' attention.
Investors should take care of following parameters into consideration before making choice of either Active Mutual fund or Passive mutual fund.
a) Your risk taking ability
b) Your investment objective
d) Income and Expenses
Though an actively managed (i.e. diversified equity funds) is bound to outperform passively managed index funds due to its diversification across different sectors and market capitalisation, you need to adopt a systematic approach towards selecting the right mutual funds because not all diversified funds provide superior returns.
An investment in passively managed funds can be considered only if one has no access to unbiased investment advice or is inexperienced to mutual fund investing. Hence whether one opts for active or passively managed funds for investing, what's required is complete cautiousness which would help you create wealth for your portfolio.
Note: The list of funds in the respective categories in the above table is not exhaustive
*Category average returns are calculated taking into account all the respective funds in the above categories
The table above reveals that as far as the performance is concerned, some actively managed diversified equity funds have clocked superior returns when compared to passively managed mutual funds - especially over a 3-Yr and 5-Yr time frame. Moreover, even though risk (as revealed by the Standard Deviation) which they have exposed their investors is slightly higher, it has resulted in better risk-adjusted (as revealed by the Sharpe Ratio) returns as well, when compared to index funds.
Hence the potential of outperforming the broader market indices showed by the performance of diversified equity funds seems to be one of the main important reasons why passively managed funds have not caught investors' attention. Moreover, not many investors are willing to settle for an index fund that will only yield the market return.
Performance of actively managed funds compared to passively managed funds
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