The biggest question faced by investors now a days is whether to go active or passive. It's a tough call to make as both the investment options have their own risks and benefits. While passive funds offer benchmark returns at low cost, active funds have the scope to generate index-beating returns.
Ideally, investors should look at combining both the approaches to get the best outcome. The blended approach can help investors outperform the respective benchmark while being mindful of cost efficiency.
The strategy requires investors to understand the efficacy of each style and device a plan that makes the best use of both. Let's understand the key features of active and passive funds and figure out their place in an ideal portfolio:
Passive funds
Passive funds can offer low cost exposure to markets and fund categories where active strategies have a difficult time outperforming. This is particularly true for large cap equities and international investing.
Passive investing is the right way to access unfamiliar markets. Investors with high risk appetite who want to take exposure to new age themes like ESG and cryptocurrency should also prefer the index fund route as good investment options in these categories are only available in overseas markets like US.
Active funds
Active funds work better in segments like midcaps and smallcaps where fund managers have flexibility. Investment in these categories is best done with greater analysis and research by the fund manager. Active funds also offer greater variety in mixed strategies through schemes like flexicap and hybrid funds.
|
Active |
Passive |
|
|
Role in portfolio |
Core holding |
Exposure to efficient markets and largecaps |
|
Benefit |
Alpha generation |
Portfolio cost reduction |
How to design a mixed portfolio?
The best way to incorporate both the investing styles is to look at passive for large cap and sectoral exposure and use active funds to take exposure to mid and small cap stocks and to mixed strategies like balanced advantage funds and flexicap funds.
Index funds and ETFs are generally the better way to take exposure to international equity and gold.
Expert take:
Rahul Jain, Senior VP Research at International Money Matters
One should have both. It doesn’t makes sense to pay higher charges for fund categories where there is little scope for alpha generation like large cap funds. Investors should opt for index fund in this space. On the active side, some categories have an edge over passive funds. Flexicap is one of them. It has room to deliver higher returns due to the freedom that fund managers get. In the hybrid space, investors have no option but to go for active funds. Passive funds do not exist in this space.
Deepak Jaggi, Co-founder and MD at Satco Wealth Managers
All of my clients have both active and passive funds. We recommend passive funds in largecap space and international equities.
In the debt portfolio, the choice between active and passive depends on the interest rate cycle. Investors should take the market condition into consideration when readying the debt strategy. When interest rates are coming down, investment should be passive heavy due to low costs. Those investing for the short term, can earn predictable return of 5.8 to 5.9% through passive funds in the current market scenario.
