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Actively Managed Funds Vs. Passively Managed Funds

Created on 30 Oct 2020

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Actively Managed and Passively Managed Fund

A person enters a machinery showroom to purchase machinery for his usage, but he has no prior knowledge about the machines. If he buys the right machinery, then it can save his time by performing better and giving him good results. However, in case he selects the wrong one, then it will be a loss for his money as well as time. 

If that person already had some categorical preferences about the machine that he would want it to fulfil, then it would be easier for him to select the ideal machinery for him.

The same things can happen with investors who have no prior knowledge of the mutual fund. To achieve a positive result from their investments, it becomes necessary for the investors to understand what the mutual fund industry has to offer and have some prior knowledge about it. 

In order to make available the best investment options for the investors, the Indian Mutual fund market categorized the mutual funds into various types (these categories can include dividing mutual funds according to structure, by Nature of the Fund, by the objective of the fund, Investments objectives, speciality, etc.) to suit the best interests of different types of investors.

Let's take you through the second type of mutual fund based on nature.

But before that, you might want to understand the different types of mutual funds based on their structure. Click here to find out.

Nature-Based Mutual Funds - Mutual funds can be divided into different types based on their nature. Some of them are as follows:

Actively Managed Funds

Actively Managed Fund is a type of mutual fund which is fully managed by the fund manager. The fund manager makes all the decisions related to the investments of the fund, which include answering various questions such as "where to invest? how much to invest? and how to invest?"

In actively managed funds, the fund manager always tries to perform extraordinarily from the set benchmark. The fund manager and the appointed market analyst, do the market research of the stock and analyze them.

The fund manager takes exposure to the different sectors apart from the index market, to do research and analysis, and then invests money to achieve higher returns. He can also take cash calls according to market performance.

Passively Managed Funds

Passively managed funds keep track of the market index or specific market segment. In this fund, the fund manager does not decide where to invest or in which securities.

This fund does not have an active fund manager which leads to lower charges. Passively managed funds do not have ambitions to perform extraordinarily in the market but try to match the performance of the index.

Index funds are the major or the most common examples of passively managed funds. If an index fund tracks a nifty benchmark, the fund will have the same 50 stocks that the nifty includes and in the same propositions.

The fund manager buys and sells the stock according to the composition of the underlying benchmark.

Since the fund's portfolio mirrors the index, the returns from the fund will be close to the index returns. In passively managed funds, the fund manager does not make any strategy to generate excess returns from the investments.

Difference Between Actively Managed and Passively Managed Fund

Both the Actively and passively managed funds are quite different from each other; hence it is important to know the difference between them. One type may be more suitable than the other, according to the investor's preference. Both these types of funds provide specific offers.

Here are three key differences between actively and passively managed funds:

Difference

Actively Managed Fund

Passively Managed Fund

Expense Ratio

In this fund, the expense ratio is slightly higher because of the active fund manager who takes the investment decisions to attain the excess returns.

In this fund, the expense ratio is cheaper as there is no fund manager to make investment decisions.

Volatility

This fund is more volatile because of the goal of the fund manager to gain a higher return. That can be undergone by the benchmark in case of a wrong decision of the fund manager.

This fund is less volatile as there are no goals of outperforming the market benchmark.

Cash Reserve

This fund offers more flexibility and diversification. In the time of market fall, the actively managed funds can maintain a higher cash reserve because of the active fund manager, which makes it more attractive.

In this fund, the fund manager cannot manage the cash reserve at the time of the market downfall because the fund manager does not take any investment decisions, which makes it less attractive in India.

Final Thoughts

Making the right decision to invest in mutual funds might be difficult as mutual funds offer a variety of options to invest. Investment in mutual funds depends on the financial goals and preferences that an investor has in his mind.

If an investor is looking for a longer time of financial goals, then actively managed funds might be suitable for him as this fund offers a variety of funds. This fund is ideal for situations like retirement, education, creating more wealth, etc. Actively managed funds offer higher returns to its investors as the fund manager does analysis and research of the market and invests in those securities which have higher market capitalization.

As the saying goes, "Higher returns come up with higher risk".

In India, investors generally prefer the actively managed funds as this fund offers higher returns and is managed through the fund manager's analysis and research of the market.

Passively managed funds are ideal funds for those who wish to take the lower risk. Investors should stay invested in this for a long period because market fluctuations in the short run will be average out in the long term.

In conclusion, the investment decision of an investor depends on their risk preference and goals. It is important for an investor to predetermine what they expect out of the investment in order to make the best possible investment choice.

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Divyanshu Kumar

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Divyanshu did his post-graduation in Financial Economics, and that's when he realized that writing about finance interests him the most. He has been writing finance content for two years and considers himself a coherent and confident writer. As a Finance content writer, he reads a lot about the subject and makes sure he is up to date with the latest updates in the market. Besides that, he is passionate about fitness and works hard to maintain a healthy lifestyle.

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