Passively managed funds are in the news again. As per latest media reports, assets in passively managed funds in the US surpassed those in the actively managed funds in the month of August 2019.

In India, assets under passively managed funds (index funds and ETFs) are rising steadily as well.

Though actively managed funds continue to dominate the mutual fund industry, investments in passively managed funds have been gaining traction since 2015, after employee provident funds started investing in ETFs.

Graph 1: Rise in AUM of passively managed funds in the last one year

Includes ETFs and Index Funds, data prior to April 2019 includes only ETFs
(Source: AMFI)

In 2018, various macro-economic conditions caused the markets to remain volatile. Hence, many funds, across categories failed to outperform their benchmark. This could be a reason why investors are now looking at passively managed funds.

[Read: Are Your SIPs Giving Negative Returns? Here’s What To Do…]

Besides, SEBI’s guidelines on mutual fund classification reduced the funds’ flexibility to invest across market capitalisation, which in turn affected the returns on actively managed funds.

Does this mean that investors should switch to passively managed funds?

Let’s look at how actively managed and passively managed funds have performed over the years.

Table: Top 5 actively and passively managed funds

  Returns (Absolute %) Returns (CAGR %)
Scheme Name 1 Year 3 Years 5 Years
Actively managed funds
SBI Small Cap Fund -9.16 12.29 17.04
Mirae Asset Emerging Bluechip 0.10 11.98 16.44
Motilal Oswal Multicap 35 Fund -6.28 7.92 14.39
Canara Rob Emerg Equities Fund -9.00 8.66 13.34
Axis Focused 25 Fund -3.98 11.90 13.26
Passively managed funds
ICICI Pru Nifty Next 50 Index Fund -12.19 5.24 9.29
IDBI Nifty Junior Index Fund -11.74 5.12 9.18
SBI-ETF Sensex -1.75 9.71 7.98
ICICI Pru Sensex ETF -1.65 9.61 7.71
HDFC Index Fund-Sensex -1.99 9.47 7.66
Average returns of actively managed funds -7.23 5.74 8.62
Average returns of passively managed funds -5.35 7.71 6.35
S&P BSE 500 – TRI -7.55 7.13 7.89

Data as on September 18, 2019
(Source: ACE MF)

The average returns of actively managed funds lagged behind the average returns of passively managed funds as well as the S&P BSE 500 – TRI index in the 1-year and 3-year period. However, in the longer time horizon of 5 years, the average returns of actively managed funds outpaced average returns of passively managed funds and the index.

In fact, returns of the top 5 actively managed schemes on a 5-year returns basis beat the returns of the top 5 passively managed funds by a remarkable margin.

A time horizon of less than 5 years is too short a period to accurately gauge the performance of equity schemes. Thus, the poor performance of actively managed funds in the short run should not be a cause of worry as long as it manages to provide meaningful returns in the long run.

Since the fund managers of actively managed schemes take active calls based on the changing market conditions, the recent correction in the equity markets provides them a valuable opportunity for alpha generation. They will now be able to pick beaten down stocks that have the potential to rise in the coming years.

[Read: Why You Should Not Ignore Worthy ‘Value Funds’ Now]

Markets are expected to remain volatile in the near term as a result of the on-going slowdown in the economy. To tide over the volatility, you can opt for the systematic investment plan route (SIP) that offers you the benefit of wealth-compounding and rupee-cost averaging.

According to the latest CRISIL-AMFI report, if you opt for the SIP route, the instances of negative returns decline as the investment horizon increases. Further, the probability of wealth-creation rises as the tenure of SIP investment increases. One must note that investments in ETF do not offer the SIP facility.

Graph 2: SIP option can prove fruitful in the long run

(Source: CRISIL- AMFI report)

Low cost of investment is one of the reasons why many advisers suggest investing in passively managed funds.

Although the cost of investing is relatively expensive in equity-oriented schemes, if you, as an investor, select a worthy equity mutual fund scheme and opt for the Direct Plan, the benefits (the returns) can outweigh the cost of investing in the long run.

An actively managed equity fund amidst the turbulent times can display its ability to generate ‘alpha’ (multiply wealth in the long run) if the fund manager handles the portfolio astutely — and provided you, as an investor, are researching enough to prudently select such an actively managed diversified equity scheme/s.

[Read: Why Bet On High Alpha Funds In This Gloomy Market]

It may not be the best time to park hard-earned money in a passively managed fund because all you would clock is returns close to that of the benchmark index with a beta of close to 1.0.

Notably, India’s mutual fund AUM as percentage of GDP is just 11% as compared to the world average of 62%. Thus, there is ample scope for the mutual fund industry to grow. Therefore, India is unlikely to run out of alpha-generating potential of actively managed funds any time soon.

Given that market valuations have corrected from earlier highs and there’s a sufficient margin of safety, it creates the right climate for active fund managers to do value hunting with a number of stocks trading lower compared to their 52-week high. So, if you wish to multiply your investment returns in the volatile times, build an equity mutual fund portfolio with Alpha Funds.

What are Alpha Funds?

Alpha Funds are “winners amongst the winners”.

Alpha Funds make the rest of the winners shy of their performance. When the winners might rake in double-digit returns, the Alpha Funds are the ones that have the potential to rake in TRIPLE digit returns in the long term! That’s why they are, in a sense, super-special in their own right.

This article first appeared on PersonalFN here.

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