Mutual Funds (Actively Managed Schemes) vs Index Funds (Passively Managed Schemes)

While mutual funds can be actively managed or passively managed, index funds are a category of passively managed mutual funds. This article compares key aspects of mutual funds and index funds to help investors understand these investment categories better.

1. Management Style

• Active mutual funds aim to outperform a benchmark or index. These funds are managed by fund managers who use their skill, research, processes, and expertise to pick stocks and manage the fund portfolio as per the investment strategy to deliver returns better than the benchmark.

Example: If a mutual fund scheme delivers more returns compared to its benchmark for a period, it is said to have outperformed the benchmark by the difference in returns.

What are benchmarks?

A benchmark is a standard against which something is compared. Investors use benchmarks to measure the performance of securities, mutual funds, exchange-traded funds, portfolios, or other investment instruments. For instance, the NIFTY 50 Index benchmark, is a group of fifty largest listed companies. As the companies in the NIFTY 50 Index do well, the NIFTY 50 Index price rises. If the MF scheme being compared to it has a group of companies that are doing even better than the NIFTY 50 companies, the MF scheme outperforms its benchmark. 

• Index funds are passively managed by investing in a basket of stocks that represents a particular index and aim to replicate the performance of an underlying index.

For example: If the NIFTY 50 Index has a 5% weight for a large bank, the index fund replicating the NIFTY 50 Index will also have the exact same stock and weight.

2. Investment Objective

• Active mutual funds aim to outperform a benchmark and deliver returns higher than the benchmark.
• Index funds have an objective to replicate the performance of the underlying index / benchmark as closely as possible and to minimize tracking error.

3. Fees

• Active mutual funds comparatively charge higher fees as they are actively managed and require more fund manager discretion.
• Index funds comparatively charge lower fees as they are passively managed and require less fund manager discretion.

4. Risk

• The risk in active mutual funds depends on the type of scheme.
• The level of risk associated with index funds is determined by two factors: firstly, the risk inherent in the underlying index and secondly, the degree to which the index funds are able to mirror the underlying index (measured by tracking error).

Table: Active vs Passive Mutual Funds

Conclusion:

Active mutual funds are suitable for investors who are willing to accept higher risk in pursuit of higher returns compared to the benchmark. On the other hand, index funds are better suited for investors who seek simplicity in their investments and lower costs. Before investing, it is important for investors to understand their investment goals, risk tolerance, and investment horizon to make an informed investment decision.

The information contained in this document is for general purposes only and not an investment advice. Readers should seek professional advice before taking any investment related decisions.

MUTUAL FUND INVESTMENTS ARE SUBJECT TO MARKET RISKS. READ ALL SCHEME RELATED DOCUMENTS CAREFULLY.