Investors turn to passive funds as active funds lag

Synopsis

Active equity mutual funds have failed to beat their benchmark indices over the past year. This underperformance has revived the debate on shifting investments to low-cost passive funds. Large-cap, flexi-cap, multicap, midcap, and smallcap funds all lagged their respective benchmarks. Despite this, wealth managers advise against completely abandoning active funds.

Mumbai: Active equity mutual funds across categories, including large-cap, flexi-cap, multicap, midcap and smallcap funds, have failed to beat their benchmark indices over the past year. The underperformance has revived the debate on whether investors should increasingly shift their core allocations to low-cost passive funds.

Popular categories such as large-cap funds returned 5.65% over the past year, compared with the BSE100 Total Return Index (TRI), which gained 7.44%. Flexicap funds returned 5.86%, trailing their benchmark BSE500 TRI that returned 8.62%, while multicap funds delivered 6.3% against the Value Research Multicap TRI index return of 8.73%.

"Active funds usually underperform during downtrends and outperform during uptrends as the benchmark has a large number of stocks, whereas fund managers hold, on average, 60-80 high-quality stocks," said Chetan Nandani, founder of Prime Care Investments. Nandani said since portfolio weightages differ from benchmark allocations, performance variance can occur on both sides.

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‘But don’t write off active funds entirely’

The midcap and smallcap categories lagged their benchmarks. Midcap funds gained 10.91% compared with the BSE 150 Midcap TRI, which returned 12.83%, while smallcap funds gained 5.36% against the BSE Smallcap 250 TRI return of 6.53%.

Passive funds typically have lower costs than actively managed funds and do not involve fund manager bias. Despite the underperformance over the past year, wealth managers advise investors not to write off active funds entirely.

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Financial planners say the trend could push investors towards a barbell strategy — using passive funds for core largecap exposure while relying on active managers in mid and small caps.

“From a portfolio construction perspective, investors need to have a balanced allocation between passive and active strategies,” said Kunal Valia, founder of Statlane, a Sebi-registered research analyst. Valia said passive funds can form the core exposure in relatively efficient segments such as large caps and midcaps, offering cost efficiency and reliable benchmark tracking. At the same time, selective allocation to high-quality active managers in segments such as flexicap, large and midcap, multicap, and smallcap can provide opportunities for excess returns.

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