Right from the 1970’s, mutual funds have grown all across the world at a steady rate. In fact, there has been a rapid growth in mutual funds in the last decade. People opt for active or passive funds whenever they choose to invest in mutual funds. In the early days of mutual funds, the market share of active funds was very high and that of passive funds was quite low. However, we see that this trend has been changing and in the recent years passive funds have almost come at par with active funds. More and more people are opting to choose for passive funds rather than active funds.
One needs to know that the target audience of both active and passive funds is different.
Passive funds are those funds in which the fund manager does not have to work actively. The investment is done according to the index. Popular index funds in India include that of NIFTY 50 and SENSEX. As the name suggests, in case of active funds, the fund manager has to work actively. The target of these active funds is to provide better returns than the benchmark index. This is done by either taking higher risk for getting higher returns or by investing in big companies and getting stable returns.
The expense ratio of active funds is slightly higher than that of passive funds. Expense ratio is the fees charged by the fund manager in return for its services. Keeping track of the expense ratio becomes highly crucial in order to maintain a stable flow of returns. According to SEBI the maximum expense ratio for active funds can be 2.25% and that of passive funds can be 1%. However, in practice, this ratio comes down to 0.3%.
The first index fund was launched in 1976 by John C. Bogle, the founder of Vanguard. The aim was to provide people with a facility to invest at trusted places and bear a less expense ratio. This custom of passive funds grew in the US and subsequently elsewhere. In India, in 2019, out of the total money invested in mutual funds, 16% came from just passive funds and ATFs whereas this share was just at 3% in 2015. This shows a rapid growth of passive funds in the recent years. A larger base is attracted to mutual funds because of the low risk and stable returns. As a result, even tier-2 and tier-3 cities are seeing growing investments in mutual funds. This is also a consequence of growing financial awareness among the masses.
The SIPS have grown in the past four years from Rs. 33.1 billion in June 2016 to Rs. 73 billion in November 2020. Actually, passive funds are ideal for those who don’t have a lot of knowledge about mutual funds but still want stable returns. This classification encompasses a lot of people, much more than those willing to put in the time and effort involved in managing active funds. It involves keeping a constant check over the fund manager, their actions and measures. Judiciously managing passive funds involves keeping a track of the expense ratio as well as the tracking error. Both should be low. If only the expense ratio is low and not the tracking error, it brings us back to square one.
Passive funds have really taken over the times as even investment moguls like Warren buffet encourage people to go for passive funds. The decision should however be based on the present circumstances of the investor, whether they should opt for active or passive funds.
Passive and other topics are discussed at the Faculty of Commerce and Business Management at Amrapali Institute, Haldwani. Amrapali Educational Institute is a top ranked institute in Uttarakhand.