Many types of mutual funds invest in asset classes like equity, debt and money market funds. There is another way to classify these mutual funds based on how they are managed.
Some of the mutual funds replicate an index while some of the mutual funds are actively managed based on the expertise of the fund manager. However, there is not a huge difference when it comes to returns earned.
In this blog, let us understand the meaning and nuances of both these types of funds.
What are Active Funds?
Active funds are managed by professional fund managers who decide which securities to buy, hold, or sell. The aim is to outperform a specific benchmark index by using research, market analysis, and strategic decision-making.
Due to the active involvement of fund managers, these funds typically incur higher management costs.
Features of Active Funds :
● Professional oversight: Fund managers use expertise, research, and market insights to guide their decisions.
● Higher fees: Active funds come with higher management costs and expense ratios due to the hands-on approach.
● Potential for higher returns: The aim is to generate returns that exceed the performance of the benchmark index, although success depends heavily on the manager’s skill. Based on data, active funds generate a return of only 2 to 3% extra or less, which is almost equal to the expense ratio of active funds.
● Flexibility: Fund managers can adjust the portfolio to respond to market trends, economic conditions, or specific stock performance.
Top Performing Actively Managed Funds:
What Are Passive Funds?
Passive funds are index funds that aim to replicate the performance of a particular market index rather than outperform it. The fund holds the same stocks as the benchmark index, in the exact proportion in order to closely mirror the index’s performance.
Since the portfolio construction follows the index, fund managers play a minimal role, hence there is a very low or no management fee.
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Features of Passive Funds
Low cost: With limited need for active management, passive funds typically have lower fees and expense ratios.
Predictable performance: Returns match the benchmark index, minus minimal tracking errors and expenses.
No outperformance goal: These funds are designed to mimic market movements, not beat them.
Top Performing Passively Managed Funds :
Active vs Passive Funds
1. Investment Approach
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Active funds: Involve a hands-on approach with the fund manager actively researching and adjusting the portfolio.
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Passive funds: Focus on replicating a benchmark index, with limited managerial intervention.
2. Expense Ratio
- Active funds: They charge higher fees due to frequent trading.
- Passive funds: A more affordable option with low management costs.
3. Returns
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Active funds: Aims to outperform the benchmark by using the manager’s expertise, though results can vary.
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Passive funds: Seek to match the returns of the benchmark index and provide predictable but limited growth.
4. Risk Profile
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Active funds: It is riskier, especially if the strategy involves equity exposure, but may offer higher rewards.
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Passive funds: Reduces unsystematic risks through rule based investing, but returns are limited to market movements.
Conclusion
Choosing between active vs passive funds depends on your financial goals, risk tolerance, and cost considerations. A balanced mix of both strategies can provide diversification and stability.
Active funds suits investors seeking higher returns and willing to take on more risk, while passive funds are ideal for those looking for low-cost, steady growth. Your personal financial plan will ultimately determine the right allocation.
By understanding the nuances of each type, you can make an informed decision that aligns with your long-term objectives.
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