When it comes to mutual fund investment, many investors get confused between passive funds and active funds. These are the types of mutual funds that are available for all investors like residents and Non-Resident Indian(NRI), and Overseas Citizen of India(OCI) to invest in. However, confusion arises between the meaning of the fund, key differences, and which one is better between active and passive funds. Find out all you need to know about the key differences, pros and cons, and the best funds to choose between active funds vs passive funds in this blog.
What are Active Funds?
Active funds are managed by fund managers who make decisions about how to allocate assets to outperform the market. These managers use research, market forecasts, and their judgment to buy and sell securities. Active funds are also known as actively managed portfolios. In actively managed funds, the fund manager is more involved, making active decisions on the stocks and bonds and rebalancing them frequently as the market fits right. While they offer the potential for higher returns than the market index, they typically come with higher fees and expenses than passive funds.
Also read: What are Balanced Funds, Benefits and How to Invest?
Key Characteristics of Active Funds:
- Active Management: Fund managers actively make investment decisions to outperform a specific benchmark.
- Higher Costs: Due to extensive research and trading, active funds typically have higher expense ratios.
- Potential for Higher Returns: The goal is to beat the market, providing the potential for higher returns.
- Flexibility: Managers can adapt to market changes and take advantage of investment opportunities.
Also read: Aggressive Hybrid Funds for NRI: Meaning, Benefits, Taxation & How to Invest
What are Passive Funds?
Passive funds are investment funds that aim to replicate the performance of a specific market index. They do not seek to outperform the market but to mirror its returns. The most common type of passive funds is index funds, including ETFs (Exchange-Traded Funds). They are also known as passively managed portfolios. The fund manager does not make active decisions but more of maintains the same stance and ratios as that of the mirroring benchmark Index like Nifty or BSE Sensex to ensure the portfolio aligns with the index. These portfolios have lower fees but typically achieve returns similar to the market without aiming for higher gains.
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Key Characteristics of Passive Funds:
- Replication: Passive funds track a specific index, such as the BSE Sensex or Nifty.
- Low Costs: Since they require less management, passive funds typically have lower expense ratios.
- Transparency: Holdings in passive funds are usually disclosed regularly, providing transparency to investors.
- Simplicity: Ideal for investors looking for a straightforward approach without frequent trading.
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Key Differences between Active Funds vs Passive Funds
- Active Funds are created around a specific theme or a specific strategy by experts, Whereas Passive Funds are designed to replicate the performance index of SENSEX and NIFTY.
- Active Funds aim to surplus the performance of the broad market index, Whereas Passive Funds try to match the performance of the market.
- Active Fund’s expense ratio ranges from 0.5%-2.5% depending on the debt composition, Whereas Passive Fund’s ratio does not go above 1.25%.
- Active funds are managed by the fund managers who select underlying securities based on market conditions, fund themes, and objectives. Whereas Passive fund managers simply track market indices, no regular funds are required.
- Active funds have higher turnover which may lead to greater capital gain distribution compared to passive funds. Whereas Passive fund’s capital gain is lower compared to actively managed funds.
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Pros and Cons of Active Funds vs Passive Funds:
- Pros of Active Funds: Active investing generates higher returns than passive investing only if the fund manager can successfully do better than the index.
- Cons of Active Funds: If the fund manager fails to surplus the index in that case active investing can give lower returns than passive investing.
- Pros of Passive Funds: Passive investing gives regular, constant, and stable returns as it tracks the performance of the index.
- Cons of Passive Funds: Passive investing gives limited results as it cannot overperform and it lacks diversification and customization as it is restricted to securities and weightage of the index and it can not be adjusted to investor’s needs.
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How to Choose Between Active Funds vs Passive Funds
The choice between active funds and passive funds depend on several factors, including your investment goals, risk tolerance, and investment horizon.
- Active Funds Might Be Right For You If:
- You are willing to take on higher costs for the chance of higher returns.
- You trust in the expertise of fund managers and their ability to outperform the market.
- You have a higher risk tolerance and are comfortable with the potential for underperformance.
- Passive Funds Might Be Right For You If:
- You prefer lower fees and consistent market returns.
- You are investing for the long term and want a simple, hands-off approach.
- You value transparency and predictability in your investments.
Also read: 10 Mutual Funds That Doubled Wealth In 5 Years
How to Invest in Active Funds or Passive Funds as NRI/OCI?
NRIs can legally invest in mutual funds in Indian markets. This includes NRIs, Persons of Indian Origin (PIOs), and Overseas Citizens of India (OCIs). There are a few legal mandates like getting their Mutual Fund KYC done along with adhering to the rules of FEMA, SEBI, and RBI. Once your KYC is done, you can invest in domestic and international mutual fund schemes offered by Asset Management Companies (AMCs) via SIPs or lump sum.
Getting your Mutual Fund KYC is mandatory to open an account to invest in mutual funds in India irrespective of the investment amount. The Securities and Exchange Board of India (SEBI) has specified a set of regulations under the Prevention of Money Laundering Act (PMLA), 2002 which mandates that mutual fund houses and intermediaries perform their due diligence on investors before they are compliant to make investments.
For more info on NRIs, PIOs, and OCIs, you can refer here.
Also read: Step-by-Step Guide for NRIs to Pick a Winning Mutual Fund
Wrapping Up
Both active funds and passive funds offer unique benefits and challenges. Active funds offer the potential for higher returns through expert management but come with higher costs and risks. Passive funds, on the other hand, provide a low-cost, straightforward way to achieve market returns, making them ideal for many investors. Assess your financial goals, risk tolerance, and investment strategy to determine which approach aligns best with your needs.
Invest in NRI Mutual Funds with SBNRI
NRIs can now download the SBNRI App and choose to invest in different NRI mutual fund schemes in India with ease. You can also get detailed mutual fund advice from experts at SBNRI. Also, visit our blog and YouTube channel for more details.
SBNRI is an authorized Mutual Fund Distributor platform & registered with the Association of Mutual Funds in India (AMFI). ARN No. 246671. NRIs willing to invest in mutual funds in India can download the SBNRI App to choose from 2,000+ mutual fund schemes or can connect with the SBNRI wealth team to better understand Mutual Fund investments.
FAQs
Which is better, an active or passive mutual fund?
- Both active funds and passive funds offer unique benefits and challenges. Active funds offer the potential for higher returns through expert management but come with higher costs and risks. Passive funds, on the other hand, provide a low-cost, straightforward way to achieve market returns, making them ideal for many investors.
What is the main difference between active and passive funds?
- In active funds, the fund manager is more involved, making active decisions on the stocks and bonds and rebalancing them frequently as the market fits right while in passive funds, the fund manager does not make active decisions but more of maintains the same stance and ratios as that of the mirroring benchmark Index like Nifty or BSE Sensex to ensure the portfolio aligns with the Index.
What is an example of a passive fund?
- Here are some of the examples of passive funds:
- Passive index funds.
- Exchange-traded funds (ETFs)
- Fund of funds investing in ETFs
Which has higher fees, passive or active investing?
- Active management fees can be from anywhere between 0.2% and 2% of the assets under management (AUM) annually. Whereas the expense ratios seen in passive ETF investment options, average between 0.1% and 1%.
Is ETF a passive fund?
- Yes, ETF is also a passive fund. EFT’s purpose is to match a particular market index, resulting in the management style known as passive management.
