Active Funds Vs Passive Funds, Who Gives Better Returns?
Do active funds give better returns than passive index funds.
Active funds vs passive funds is a topic with much interest.
If you talk to personal finance gurus they will tell you passive funds is the way to go. Financial advisors will tell you that you are sacrificing ‘alpha’ if you don’t go for active funds. They might also tell you that there is a science to picking the best fund.
So, as a normal, happy go lucky, investor with a job that keeps you busy, what should you do.
Well, for starters, realise that you cannot ‘not be involved’ in your money decisions. Don’t trust every bit of advice you get. Look at the numbers yourself. Also, don’t trust conclusions others will draw from the numbers. Look at the numbers yourself.
So, for this debate let us look at some numbers. I got my hands on the SPIVA India Scorecard, mid-year 2021. Thanks to a generous friend.
The report states the below for large-cap equity funds:
“Over the one-year period ending in June 2021, the S&P BSE 100 was up 55.96%, with 86.21% of funds underperforming the benchmark. Over H1 2021, 53.13% of the funds underperformed the S&P BSE100.”
Huh!?
Ok, let us translate it into normal English.
From July 2020 to June 2021, only 14% of large-cap mutual funds have given better returns than the S&P BSE100 index.
Further, the report says that only 34% have done better than the index over the last 10 years. Also, about 30% of the funds have shut down in the last 10 years.
What conclusion can Mr Layman derive from this?
1. It is possible to beat the index, 14% of large-cap funds have done it.
2. It is very hard to beat the index, only 14% of large-cap funds have done it. These are all funds with a full team of researchers and well-heeled fund managers. Even within this elite, only 14% have managed to deliver an ‘alpha’.
3. 30% of the funds which existed 10 years ago, do not exist anymore.
The SPIVA report covers other types of indices but for this discussion, I am sticking to large-cap only. Of course, the result is the same in the other indices too, the index has done better than the majority of funds.
As an investor without access to a crystal ball, it will be very hard to predict which fund will beat the index. This particular report does not talk about any fund consistently beating the index. However, while looking this up previously I have struggled to find such a fund.
Besides, let us look at the returns – the BSE100 has given 56% returns over a 1 year period. The Nifty 50 over the same period has given 58% returns.
These are not numbers to scoff at. ( the smart reader that you are, you have picked up that the base was covid impacted in both cases).
Index returns are pretty good on their own
The point I am making is that the index has given very good returns.
In personal finance planning rarely will you assume more than 10% for equity returns. The small extra return that an active fund can provide is probably not worth it. Especially if you consider the probability of picking the wrong fund.
So far I have not even touched upon the topic of fees. There is a separate post on active funds and their fees that you can refer to. Suffice it to say that the active fund fees reduce their returns further compared to the index. While on the topic, you can read about financial advisors too.
My conclusion (you should draw your own) is that index funds are the right choice for a passive investor.
So, what index fund should we look at.
I would keep it simple here too. Just buy the top 100 companies in the country. The two indices that I invest in – Nifty 50 and Nifty Next 50.
There are plenty of fund houses providing funds for these. There are also ETFs. I actually invest in the ETFs.
One thing to keep in mind is dividends. If you are in a high tax bracket you don’t want the dividends coming to you, you want them reinvested in the fund. So, look for funds/ETFs which will reinvest the dividends.
Invest in the index and watch your money grow. Passively!
This article is for informational purposes only. It should not be considered Financial or Legal Advice. Not all information will be accurate. Consult a financial professional before making any significant financial decisions.
