Active vs Passive Funds: As passive investing steadily gains popularity in India, investors are increasingly questioning whether active or passive mutual funds are better suited for long-term wealth creation. In a detailed discussion with Zee Business on market trends and investor behaviour, experts highlighted that the decision is not about choosing one over the other, but about understanding their roles in a portfolio.

Explaining the fundamentals, Mohit Gang, CEO, Moneyfront, said passive investing is built on the philosophy of tracking a market index rather than trying to beat it.

He noted that passive funds invest in indices such as the Nifty 50, where the portfolio automatically mirrors the top companies by market capitalisation. “You are essentially participating in the average returns of the market instead of trying to outperform it,” he explained.

The idea gained global prominence through Vanguard founder Jack Bogle, who promoted low-cost index investing. According to Gang, the philosophy rests on the belief that consistently beating the market is extremely difficult for active fund managers over long periods.

He also added an important structural point: indices are self-cleansing in nature. Companies that perform well gradually enter the index, while weaker performers exit over time, making the index a continuously evolving representation of the market.

He pointed out that India’s passive investing market is still developing. “Around 16–18 per cent of the Indian mutual fund industry is now in passive strategies, but globally this number is much higher,” he said.

Siddharth Srivastava, Head–ETF Product & Fund Manager, Mirae Asset, said passive investing has grown due to multiple factors, and not just because of active fund underperformance.

He explained that globally, passive funds initially gained traction in periods where active funds struggled to consistently beat benchmarks. However, this was only one part of the story. Low-cost structures, transparency, ease of access through ETFs, liquidity benefits, and growing investor awareness have also played a major role.

“Investors know exactly what they are investing in. For example, a Nifty 50 ETF clearly tracks 50 companies. This transparency is a big attraction,” Srivastava said.

He also highlighted innovation as a key driver of growth. Smart beta strategies, factor-based investing, thematic ETFs, and international ETFs have expanded the passive ecosystem far beyond simple index tracking.

He added that passive investing is not inherently low-risk. The risk spectrum is wide — while low-volatility index strategies may be relatively stable, momentum or factor-based ETFs can be significantly more volatile. In addition, niche or smaller index ETFs can face liquidity issues, sometimes trading at a premium or discount to their net asset value (NAV).

Explaining performance dynamics, Mohit Gang said both strategies have strengths and limitations.

Passive funds offer simplicity and stability, but lack flexibility. “If a sector like IT underperforms, a passive fund still has to maintain its weight in the index. It cannot reduce exposure,” he said.

He also emphasised that indices are structurally designed systems where good companies enter and weak companies exit over time, but the portfolio still cannot make tactical deviations.

Active fund managers, on the other hand, can adjust portfolios based on market conditions. They can reduce exposure to weak sectors, increase allocation to outperforming ones, or even move to cash when required.

However, this flexibility does not guarantee outperformance. “Beating the index consistently is extremely difficult,” Gang said.

He added that active management tends to work better in mid-cap and small-cap segments, where market information is less efficient and stock-picking opportunities are higher.

Both experts agreed that risk exists in both active and passive strategies, but in different forms.

Gang explained that passive investing removes fund manager risk but does not eliminate market risk. Investors remain fully exposed to market movements without the ability to intervene during downturns.

He also highlighted that in certain passive strategies — especially momentum, factor-based, or niche thematic ETFs — risk can actually be higher than traditional active funds due to concentration and volatility.

Active funds, meanwhile, carry the risk of underperformance if fund manager decisions go wrong. However, they also have the potential to reduce losses during volatile periods through tactical allocation, including cash positioning.

He also noted that liquidity risks can emerge in smaller or less-traded indices, where ETFs may trade at a premium or discount to NAV due to market demand-supply imbalances.

A major advantage of passive funds is their low-cost structure. Gang highlighted that active equity funds typically charge expense ratios of 1–2 per cent, while passive funds may charge a fraction of that.

“This difference compounds significantly over 15–20 years and can materially impact final returns,” he said.

Both experts agreed that a blended approach is the most practical strategy for most investors.

Gang suggested that large-cap exposure is better handled through passive funds such as index funds, while mid-cap and small-cap allocations may benefit from active management due to inefficiencies in those segments.

Srivastava recommended a “core and satellite” approach.

“For the core, investors can use index funds like Nifty 50 or Nifty Next 50. For mid-caps, a mix of active and passive can work. Small caps still offer strong opportunities for active management,” he said.

He also noted that investors are increasingly using passive funds not just for core allocation but also for tactical exposure—such as thematic investing in defence, metals, gold, or international markets.

Srivastava added that India now has more than 650 ETFs and index funds across sectors, themes, and strategies, including low-volatility, momentum, equal-weight, and factor-based products, enabling investors to build diversified portfolios even without active fund managers.

Experts also pointed to strong flows in passive products during recent market cycles. Gold ETFs, for example, saw significant inflows during periods of volatility, reflecting increased investor preference for transparent, low-cost instruments.

Globally, passive investing has already overtaken active management in markets like the United States. Europe and Japan also show strong passive adoption.

“India is moving in the same direction, but we are still at an early stage. This is just the beginning,” Gang said.

Experts emphasised that passive investing is not a replacement for active funds but a complementary strategy.

Passive funds offer low cost, transparency, and long-term market returns, while active funds provide flexibility and potential outperformance in less efficient markets.

Ultimately, the right strategy depends on an investor’s risk profile, financial goals, and time horizon—and a balanced combination of both may offer the most effective path to wealth creation.