Actively Managed Funds and Passive Funds
Actively managed funds are funds in which a manager or a management team makes decisions about how to invest the fund's money, within the broad parameters of the investment objective of the scheme. Since this increases the role of the fund manager, the expenses for running the fund turn out to be higher. Investors expect actively managed funds to perform better than the market.
Passive fund invests on the basis of a specified index, whose performance it seeks to track. Thus, a passive fund, tracking the NIFTY-50 or BSE S&P BSE SENSEX, would buy only the shares that are part of the composition of that index. The proportion of each share in the scheme’s portfolio would also be the same as the weightage assigned to the share in the computation of the index.
Therefore, the performance of these funds tends to mirror the concerned index. Yet, there are gaps in the performance of these funds as compared to the index. This gap in performance is its tracking error. It can be positive or negative i.e. the passive fund performance can be better or worse than the concerned index, for various reasons.
Passive funds are not designed to perform better than the market. On account of linkage to the index, they are also called index schemes. Since the portfolio is determined by the index itself, the fund manager has no role in deciding on investments. Therefore, these schemes have low running costs.
NIFTY-50: An equity market index constructed on the basis of 50 shares traded on the National Stock Exchange
S&P BSE SENSEX: An equity market index constructed on the basis of 30 shares traded on the Bombay Stock Exchange.
The index, on which a passively managed scheme is constructed, is called its benchmark. Similarly, even active schemes have a benchmark – a standard against which scheme performance can be compared. A benchmark is announced when every scheme, active or passive, is launched.
Exchange traded funds (ETFs) are a type of open-end index fund that are listed in the stock exchange. Investors need a demat account for buying units of ETF. Post-NFO, retail investors can transact in ETF units only in the stock exchange.
The new cadre of distributors can sell both actively managed and passive schemes, subject to the limitations mentioned.
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