scorecardresearchIs it safer to choose passive funds over active funds? Let's decode

Is it safer to choose passive funds over active funds? Let's decode

Updated: 26 Apr 2022, 03:16 PM IST
TL;DR.
We shed a light on the reasons that make choosing passive funds a relatively better choice than active funds
Incidentally, mid cap and small funds have more opportunities of beating the benchmark.

Incidentally, mid cap and small funds have more opportunities of beating the benchmark.

Despite a lot of efforts which go into selecting a fund that outperforms the market index consistently, experts opine that it’s safer – considerably – to choose a passive fund, particularly for small and new investors most of the time. According to a Fortune report, more than 70 percent of active funds in India underperform their benchmarks in the five years period.

Even the famous book A Random Walk Down Wall Street by Princeton University’s economist Burton Gordon Malkiel also brings home this very lesson.

The author examines both technical and fundamental analysis in the backdrop of academic research studies of these methods. He highlights some lacunae in these techniques and said these methods will give inferior results as compared to passive strategies.

He also condemns selecting actively managed mutual funds based only upon past performances. He cites studies indicating that actively managed mutual funds often underperform in years following their successes, moving toward the mean. However, some financial experts have a contrarian viewpoint to this.

"Index Funds work well in countries where the stock markets are at the matured stage and they have gone past emerging and growth phases. In India, there are continuous opportunities for businesses to improve their efficiency. The potential of investing in such companies would be more through active funds as the fund manager would look into multiple factors and not just market capitalisation," says Harshad Chetanwala Co-Founder MyWealthGrowth.com

 

Large Cap Funds that failed to meet benchmark index in past one year

Large cap funds                                         Returns (%)Benchmark (%)
Axis Bluechip Fund                         17.0720.66
DSP Top 100 Equity Fund               11.1620.66
Edelweiss Large Cap Fund              18.9720.63
HSBC Large Cap Equity Fund           16.0020.63
Indiabulls Bluechip                        15.0520.63
JM Large Cap Fund                           19.8420.66
PGIM India Large Cap Fund          12.5620.63
Union Largecap Fund                    19.6120.66

(One year direct returns; Source; AMFI data as on March 31, 2022)

The number of funds that beat the benchmark has been falling. Incidentally, mid cap and small funds have more opportunities of beating the benchmark.

While suggesting the right mix of funds in the portfolio, Mr Chetanwala says, "A blend of active and passive funds could work better over the long term for investors in India."

Benefits of choosing passive funds: By investing into passive funds such as those linked to the benchmark indices, investors can generate the returns mapped to the market.

This strategy is easy to embrace because one doesn't need to bother about the right fund manager or switching funds as a result of underperformance.

Even between index fund and ETF, most investors find index funds more suitable. This doesn't require a brokerage-cum-demat account and one can even invest via systematic investment plan (SIP).

There are some key considerations that should be kept in mind while selecting a fund.

“First and foremost, investors should avoid very small funds since they are prone to large inflows and outflows. Another thing to keep in mind is liquidity which is a concern for small funds," says Deepak Aggarwal, chartered accountant and financial advisor.

Another factor that investors should pay attention to is consistency. One can measure performance through rolling returns of five years. One should go for a fund that has performed consistently for past five years.

 

First Published: 26 Apr 2022, 03:15 PM IST