An actively managed fund is a mutual fund scheme in which the fund manager “actively” oversees and continuously analyses the portfolio of the fund, determining which companies to buy/sell/hold and when based on his professional judgment and analytical study.
The goal of active fund management is to maximize returns and outperform the scheme’s benchmark. In a passively managed fund, on the other hand, the fund manager remains inactive or passive; in the sense that the fund manager does not utilize the judgment or discretion to pick which stocks to buy/sell/hold, but instead merely replicates/tracks the scheme’s benchmark index in the same proportion.
An Index Fund and all Exchange Traded Funds are examples of index funds. The fund manager’s role in a passive fund is to merely duplicate the scheme’s benchmark index, i.e., to earn the same returns as the index, rather than to outperform it.
Mutual fund portfolios can be administered actively or passively. When we talk about portfolio management, we’re talking about how the fund manager buys and sells the underlying assets (stock, debt, gold, and so on).
An actively managed fund means that the fund manager is more involved in decision-making and is more active in determining which stocks and bonds enter and exit a mutual fund portfolio and when. The fund manager cannot control the movement of the underlying assets in passively managed funds. While this is the primary distinction between active and passive investment strategies, there are several others to consider to gain a better understanding.
What is an Actively Managed Portfolio (AMP)?
Let’s look at some examples to help us understand. Actively managed funds include equity mutual funds, debt mutual funds, hybrid funds, and fund of funds. In the case of an equity fund, a dedicated fund manager decides which stocks will enter and exit the fund based on the performance of the larger markets and economies as well as the individual performance of the stocks.
The fund manager must also decide whether to keep the existing stocks in the same concentration or whether to increase or decrease the funds invested in individual stocks.
In other words, the success of an equity fund is heavily influenced by the fund manager. We’ll use an equity fund as an example. The situation is the same for all other active management fund categories.
What is a Passively Managed Portfolio?
With the help of an example, we will also learn passive investing. ETFs (exchange-traded funds) are funds that are managed passively. The fund’s sole purpose in ETFs is to mirror the movement of an index.
The fund merely maps the index’s movement because what gets in and out of the index is decided by SEBI (Securities and Exchange Board of India), not fund managers. The performance of the index is translated into the profitability of ETFs. Expense ratio charges, management fees, or any other costs or dividends could account for the differences.
It is similar to the HDFC Sensex ETF; in that, it holds all of the equities in the same proportion as the Sensex. Its fund manager will make minor index tweaks to bring the fund into line with Sensex. If Sensex changes, the fund manager will have to make identical changes in his or her fund. The fund manager in Passive Portfolio Management is just expected to match the benchmark’s performance.
Pros and Cons: Active vs Passive Investing
Both passive and active investment approaches have their own set of advantages and disadvantages or pros and cons. Let’s examine the advantages and disadvantages of both actively and passively managed funds.
The Advantages or Pros of Actively Managed Funds:
- Alpha generating funds: Actively managed funds are excellent if the investor wants a little more than what the benchmarks have to offer. The primary goal of actively managed funds is to outperform the Sensex and Nifty indexes and produce ‘alpha’. For market research, the fund manager employs his or her experience, knowledge, and time.
The Disadvantages or Cons of Actively Managed Funds:
- Expensive: Every exceptional thing in life has a price, and a fund manager’s skill is no exception. For the fund manager’s experience and decision-making, investors will have to pay fees (known as expense ratios).
- Risk: Actively managed funds seek larger returns and, as a result, carry a higher risk than passively managed funds. This is due to the possibility that man-made decision-making systems are prone to inaccuracy.
The Advantages or Pros of Passively Managed Funds:
- Affordable: They have far lower expense ratios than active funds. The fee ratio for ETFs cannot exceed 1%, according to SEBI regulations. As of May 11, the expense ratio for the prior example we used, the HDFC Sensex Fund, is barely 0.05 percent.
The Disadvantages or Cons of Passively Managed Funds:
- Benchmarks are unbeatable: The returns on these funds are moderate. Returns may be equal to or less than those of the benchmark. They may be less expensive, but they do come with fees that may reduce returns slightly.
Passive Investing vs. Active Investing
|Sr. No.||Specifications||Active Investing||Passive Investing|
|1.||Strategy||At his or her consent, the fund manager actively alters the fund’s composition.||Only the movement of the benchmark indexes is copied by the fund management.|
|2.||Expense Ratio||Depending on the equity/debt orientation, 0.08 to 2.25 percent.||1% is the maximum.|
|3.||Returns||The fund management strives to outperform the benchmark and is frequently successful.||Returns in the same range as or lower than the benchmark.|
Read Next: “Advantages vs disadvantages of Equity Shares.”
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