Two schools of conflicting thoughts!!!
One School of Thought: “Active Funds tend to perform better than passive Funds”.
Another School of Thought: “Passive Funds are prone to less risk while still yielding better results compared to Active Funds.”
This leads us to the question of which is better? Active or Passive Funds?
Firstly we need to delve deeper into Mutual funds to understand what kind of funds would be better to invest in.
1.) Understand your Requirements First
2.) Understand the Mutual Fund Schemes
3.) The Role of Alpha in Mutual Fund Selection
4.) Basics of Active & Passive Funds
5.) Active Fund
6.) Pros of Active Funds
7.) Cons of Active Funds
8.) Passive Fund
9.) Pros of Passive Fund
10.) Cons of Passive Fund
11.) Active Fund Vs. Passive Fund
12.) What is a Tracking difference & Tracking error in the Passive Fund?
13.) Key Observations from the Analysis
14.)Adani Group stocks – Standpoint of Active & Passive fund
15.)Active or Passive Funds: Which one to choose?
16.) Choose Active Funds:
17.) Choose Passive Funds:
18.) Final Remarks:
Mutual funds are one of the investment products through which investors can grow wealth. There are many types of mutual funds for the investor to pick and choose to invest in.
before you start investing in any fund, you must first consider certain factors. Some of the factors include:
This will help determine your goals and risk appetite to help you choose the Mutual funds that will fit your needs accordingly.
Now, while choosing the funds, it is better to track the past record performance of the fund. It is not enough to look at the recent high performance of the fund to finalize your choice. Your analysis of the past performance should go back to 5, 7, 10, or 15 years to better gauge the fund’s rate of return.
There are some important statistical ratios that help investors to determine the risk-return profile of an investment. They are Alpha, Beta, Standard deviation, R-squared, and Sharpe ratio. But many investors tend to focus exclusively on additional investment return (alpha) with little to no concern for the other metrics that could potentially help them out in the long run.
This might arise the question of why Investors tend to focus exclusively on Alpha.
Alpha represents the excess returns (performance of a portfolio) earned on investment above the average benchmark return. The portfolio manager or the fund manager who manages your active funds measures the performance of the portfolio he himself carefully structured using the Alpha statistical ratio.
Alpha in particular helps to determine if your active fund’s portfolio has managed to beat the market return over a period of time. As a result of actively investing in the funds, the Alpha result may either turn out to be positive or negative.
Whereas Alpha can’t be used to measure the portfolio of Passive funds.
Let us briefly look at what Active and Passive funds are to precisely understand which is better.
Would like to actively invest by letting a fund manager and his team manage your funds or are you ok with passive investing and letting your investments grow at a similar rate to the market?
Let us dive deep to find out:
Active funds are one kind of fund in which the fund manager and his team invest based on intense research on different types of securities.
A Fund manager along with his team also would consider multiple factors such as company fundamentals, economic trends, and macro-economic factors when making investment decisions that would directly benefit you.
They seek to outperform the benchmark index to gain you profitable returns in the long run.
Passive funds are the kinds of funds that aim to track and duplicate the performance of a benchmark index. These passive funds mimic the indices like the Nifty or Sensex.
The fund manager here has no active role except to replicate the index. These funds are also referred to as tracking funds because they try to accurately mimic a set benchmark or index.
Both active and passive funds have their own merits and demerits, which might make you wonder which one is the most ideal to invest in.
Let us do a thorough analysis using data points to analyze which fund is better to invest in:
Firstly, we will compare active funds in each category index to gauge their rate of return.
Assumptions:
Lumpsum Investment: ₹ 1 lakh
Investment period: 10 years
Index: Respective category index
Returns: Annualized return
Let’s assume the Rs. 1 lakh is invested for 10 years. As Equity investments are suitable for long-term investments, the 10-year time period is chosen.
The below tabular column shows the current value of the investment at the end of the 10-year period after being invested under various categories of funds. The values are as on 19 Feb 2026.
Let’s take a deep look into each category individually:
| Scheme Name | Invested Amount | Current Value | Annualized Return (%) |
| Nippon India Large Cap Dir Gr Gr | 1,00,000 | 4,94,302 | 17.31 |
| CANARA ROBECO LARGE CAP FUND DIR GR | 1,00,000 | 4,72,931 | 16.8 |
| ICICI Pru Large Cap Fund Dir Gr | 1,00,000 | 4,71,407 | 16.76 |
| HDFC Large Cap Fund Dir Gr | 1,00,000 | 4,43,012 | 16.03 |
| Mirae Asset Large Cap Dir Gr | 1,00,000 | 4,41,907 | 16.01 |
| Edelweiss Large Cap Dir Gr | 1,00,000 | 4,36,819 | 15.87 |
| Kotak Large Cap Fund Gr Dir | 1,00,000 | 4,28,879 | 15.66 |
| Invesco India Large Cap Dir Gr | 1,00,000 | 4,28,469 | 15.65 |
| Bandhan Large Cap Dir Gr | 1,00,000 | 4,23,679 | 15.52 |
| BARODA BNP PARIBAS LARGE CAP Fund Dir Gr | 1,00,000 | 4,21,416 | 15.46 |
| NIFTY 100 TRI | 1,00,000 | 4,03,884 | 14.97 |
In the large-cap category, almost the top 10 funds have outperformed the respective index.
| Scheme Name | Invested Amount | Current Value | Annualized Return (%) |
| Invesco India MidCap Dir Gr | 1,00,000 | 6,91,616 | 21.32 |
| Edelweiss MidCap Dir Gr | 1,00,000 | 6,89,125 | 21.27 |
| BARODA BNP PARIBAS Mid Cap Fund Dir Gr | 1,00,000 | 6,76,554 | 21.05 |
| Nippon India Gr Mid Cap Fund Dir Plan Gr | 1,00,000 | 6,71,003 | 20.95 |
| Kotak Midcap Fund Dir Gr | 1,00,000 | 6,57,852 | 20.71 |
| HDFC Mid Cap Fund Gr Dir | 1,00,000 | 6,54,506 | 20.65 |
| NIFTY MIDCAP 150 TRI | 1,00,000 | 6,10,871 | 19.82 |
| Axis MidCap Dir Gr | 1,00,000 | 5,81,060 | 19.22 |
| HSBC Midcap Fund Dir Gr | 1,00,000 | 5,73,247 | 19.06 |
| Tata Mid Cap Fund Dir Plan Gr | 1,00,000 | 5,69,247 | 18.98 |
| ICICI Pru MidCap Dir Gr | 1,00,000 | 5,68,206 | 18.96 |
In Mid cap category, six active funds have outperformed the index & most of the active funds are at par with index. The reason for the slight difference is that the forth building up in the Mid & small cap segments from the beginning of this year. Once the bubble burst, things will fall back to normal.
| Scheme Name | Invested Amount | Current Value | Annualized Return (%) |
| Quant Flexi Cap Gr Dir | 1,00,000 | 6,67,780 | 20.89 |
| HDFC Flexi Cap Dir Gr | 1,00,000 | 5,91,880 | 19.44 |
| Parag Parikh Flexi Cap Dir Gr | 1,00,000 | 5,84,993 | 19.31 |
| JM Flexi Cap Dir Gr | 1,00,000 | 5,75,834 | 19.12 |
| Edelweiss Flexi Cap Dir Gr | 1,00,000 | 5,22,767 | 17.97 |
| Canara Robeco Flexi Cap Dir Gr | 1,00,000 | 4,78,231 | 16.93 |
| PGIM India Flexi Cap Dir Gr | 1,00,000 | 4,78,217 | 16.92 |
| DSP Flexi Cap Dir Gr | 1,00,000 | 4,77,769 | 16.91 |
| ABSL Flexi Cap Gr Dir | 1,00,000 | 4,76,620 | 16.89 |
| Kotak Flexi Cap Gr Dir | 1,00,000 | 4,68,745 | 16.69 |
| NIFTY 500 TRI | 1,00,000 | 4,34,094 | 15.8 |
In the Flexi cap category, the top 10 funds have outperformed the respective index.
| Scheme Name | Invested Amount | Current Value | Annualized Return (%) |
| Nippon India Small Cap Dir Gr Gr | 100000 | 778921 | 22.77 |
| Axis Small Cap Dir Gr | 100000 | 645514 | 20.48 |
| HDFC Small Cap Dir Gr | 100000 | 643263 | 20.44 |
| HSBC Small Cap Fund Dir Gr | 100000 | 637166 | 20.33 |
| SBI Small Cap Dir Gr | 100000 | 600210 | 19.61 |
| Kotak -Small Cap Gr Dir | 100000 | 597621 | 19.56 |
| Quant Small Cap Gr Dir | 100000 | 584644 | 19.3 |
| DSP Small Cap Dir Gr | 100000 | 562771 | 18.84 |
| ICICI Pru Small Cap Dir Gr | 100000 | 526951 | 18.06 |
| Union Small Cap Dir Gr | 100000 | 512617 | 17.74 |
| NIFTY SMALLCAP 250 TRI | 100000 | 471161 | 16.75 |
In the Small-cap category, the top 10 funds have outperformed the respective index.
| Scheme Name | Invested Amount | Current Value | Annualized Return (%) |
| NIFTY 50 TRI | 100000 | 3,99,498 | 14.84 |
| Bandhan Nifty 50 Index Fund Dir Gr | 100000 | 390925 | 14.59 |
| UTI Nifty 50 Index Fund Gr Dir | 100000 | 388407 | 14.52 |
| HDFC Nifty 50 Index Fund Dir | 100000 | 386469 | 14.46 |
| Tata Nifty 50 Index Fund Dir Plan | 100000 | 385256 | 14.43 |
| SBI Nifty Index Dir Gr | 100000 | 384026 | 14.39 |
| ICICI Pru Nifty 50 Index Fund Dir Cumulative | 100000 | 383560 | 14.38 |
| Nippon India Index Fund Nifty 50 Plan Dir Gr Growth Option | 100000 | 383539 | 14.38 |
| LIC MF Nifty 50 Index Dir Gr | 100000 | 378111 | 14.21 |
| Taurus Nifty 50 Index Dir Gr | 100000 | 377057 | 14.18 |
| Franklin India INDEX FUND NSE NIFTY 50 INDEX FUND Dir Gr | 100000 | 375337 | 14.13 |
| ABSL Nifty 50 Index Gr Dir | 100000 | 374177 | 14.09 |
If you look into the passive fund’s rate of returns in the long term, you will be surprised that seldom fund has outperformed the index. The tracking difference of the fund is high when compared to the index.
Tracking difference is the absolute difference between the returns of the fund and those of the benchmark at the end of the chosen investing period. It measures the actual underperformance or outperformance of the fund compared to the underlying reference index.
Tracking error, on the other hand, is a measure of how well the fund tracks the benchmark during the investment period and how closely it replicates the index. If a passive fund has a very high tracking error, it can defeat the entire purpose of passive investing.
According to the circular issued by the market regulator, SEBI on 23 May 2022, a ceiling has been prescribed for the tracking error (TE) of Index funds and ETFs other than debt ETFs/ Index funds at 2%.
Along with TE, tracking difference (TD) shall also be disclosed on the website of the AMC and AMFI on a monthly basis for tenures of 1 year, 3 years, 5 years, 10 years, and since the date of allotment of units.
From the above analysis, it is evident that active funds tend to outperform passive funds in the long run.
There are also studies claiming that over the last decade, active funds have outperformed the Index. In fact, recent studies have also uncovered the fact that the Alpha generation potential is higher in India than that of any other developed market.
The greatest advantage of active funds is that the mutual fund manager can trim their holdings in any particular stock if they expect the price volatility of that particular stock in the near term.
For example, in Jan 2023 when a US-based research agency ‘Hindenburg Research ‘questioned the Adani Group of companies on its governance & accounting practice, stocks of all 9 companies went into a free fall.
Against the backdrop of a steep fall in stock prices, the actively managed funds stayed away from Adani Group of stocks because they were skeptical of its valuation. But that is not the case with index funds as they have to mimic the index.
Adani Enterprises and Adani Ports and Special Economic Zone which are part of the Nifty50 index, have an overall weightage close to 1%. Along with these two stocks, Adani Transmission and Adani Green Energy which are part of the Nifty 100 index, have an overall weightage of 2.1%.
It’s been six months since Adani stocks tumbled due to the allegation. But the impact is still there in the passive funds. Thus, fund managers of active funds have an upper hand over passive funds.
The decision to invest in either active funds or passive funds boils down to the Individual’s goals, risk tolerance, and circle of competence.
You can choose to invest in active funds if the ability to select good active funds is within your circle of competence.
But, in case you are new to mutual funds and you have a higher risk appetite, you can hire a trustworthy Professional Financial Planner who has the competency to select good active funds.
Having a trustworthy professional Financial Planner with a good track record over the years would definitely be an advantage in navigating the market as even if the risk of loss comes up, he would be able to minimize it considerably.
Active funds from the perspective of the research analysis have been shown to generate positive Alpha making it an investment worth the risk.
When you are new to the concept of active and passive funds and have a low-risk appetite and also not have a trust-worthy professional Financial Planner on your side, then passive funds might be a better choice for you.
This choice helps you by eliminating the payment of higher fees that comes with actively managed funds. Also, similar to the Index return is guaranteed.
You can either choose to actively invest through a competent Financial Planner to achieve better returns or passively invest and gain similar to index returns. The decision to choose is solely based on your individual goals, risk tolerance, and your circle of competence.
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