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Active vs Passive Mutual Funds: Which one should you buy?

market | Oct 11, 2021 8:30 PM IST

Active vs Passive Mutual Funds: Which one should you buy?


The latest Spiva report released by S&P Dow Jones shows that 86 percent of actively managed largecap funds underperformed their benchmark indices in the last one year.

The performance of active fund managers has been the subject of heated debate for quite some time. The latest Spiva report released by S&P Dow Jones shows that 86 percent of actively managed largecap funds underperformed their benchmark indices in the last one year.

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The Spiva scorecard shows that for the 1 year period ending June 2021, almost 86 percent of largecap funds underperformed their benchmark index that is, the BSE 100.
According to the report 57 percent of mid & smallcap funds underperformed their benchmark and in the ELSS category a little over half or 53 percent of the funds underperformed the benchmark which this report takes as the BSE 200 index.
The last three Spiva reports show that the underperformance of the largecap mutual fund category has increased steadily. The midcap & ELSS categories are however showing some improvement versus the December report perhaps thanks to a buoyant equity market.
According to S&P Dow Jones, almost 66 percent of largecap funds have underperformed their benchmark over the last 10 years. Almost half the ELSS funds haven't been able to beat their benchmark in the same period. And about 40 percent of mid & smallcap funds have seen below-benchmark returns in the last decade.
The underperformance isn't just restricted to equity funds. According to Spiva, almost 71 percent of actively managed government bond funds have underperformed their benchmark and half of the actively managed composite bond funds have also not been able to beat the S&P BSE India Bond Index.
In an interview to Surabhi Updayay, Nilesh Shah, MD of Kotak Mahindra AMC said, “Investors should invest in those active funds which are able to generate alpha. Alpha may not be generated on a daily basis, it could be sometimes up and down. In 2017 lot of midcaps underperformed benchmark indices because indices had a particular IT stock which moved from 1 percent to 4 percent and most good fund managers avoided investing in that company. With the benefit of hindsight today, fund managers are proven right as that stock is down 90 percent from the top. So there will be a deliberate underperformance to index because people don’t want to compromise on their investment processes. If active funds are outperforming, invest with them because you are generating better returns than benchmark indices but if active funds are underperforming then please go and choose index funds, ETFs and fund of funds.”
Sunil Subramaniam, MD & CEO of Sundaram MF said, “A lot of speculative purchases happen in the passive space, they come in and they go out when they want but when you are talking about investing it had got to follow a 3-stage process. First stage is you got to have financial goals, then you create a financial plan and third is asset allocation. In asset allocation you can do largecap, midcap or smallcap and active, passive. That is why the advisors role is critical in choosing how much of your financial plan should come. Some advisors charge fee from the customer and so naturally they will choose either passives or they choose the direct plans of active because they want to have more money on the table from where they can charge fees. So do it yourself investors which is increasing with post millennial, they tend to look at it from ease of investing in passive, but in periods of outperformance fund managers beat index by 5-10 percent and the cost they charge is anywhere between 1-2.5 percent maximum. So you look at it over a longer period and I am sure that 1-2.5 percent fees in the long run outperformance is nothing. So for an investor you start off with 50:50, wait for a period of time, see how it is performing and ad you learn more you can shift more to active.”
Swarup Mohanty, CEO of Mirae Asset Investment Managers said, “Investors need to have a properly allocated portfolio catering to your goal. In that you have to have a core portfolio and satellite portfolio. In core you have fundamentally strong companies which give an average return and this is where the trick comes in. The trick is to select fund managers who can beat alpha and that is not getting easy thanks to the Spiva report. However I do believe they Indian fund management has enough talent to beat benchmark and active is still alive and kicking. However when you look at the intuitive and brilliant minds of the Indians, what you will see unfolding is a plethora of brilliant products coming on the passive side as well. So I do not believe that it is an active versus passive products and keep in mind that overall cost of the portfolio will also come into consideration sooner or later. So when you combine both it is possible to form some very strong portfolios catering to each and everybody’s goal.”
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