Building a Balanced Portfolio with Active and Passive Mutual Funds

The Indian MF industry has witnessed phenomenal expansion in the past decade. As of March 31, 2024, the industry’s AUM stood at a staggering Rs 55 trillion, reflecting a more than six-fold increase from Rs 8.25 trillion in March 2014. This growth is mirrored in the investor base, which has surged from 3.8 crore to 17.79 crore during the same period. Notably, a significant portion of this growth comes from retail investors, as reflected in the 14.24 crore folios under equity, hybrid, and solution-oriented schemes.

Systematic Investment Plans (SIPs) have emerged as a popular investment avenue, with a record Rs 19,271 crore invested through SIPs in March 2024 alone. This highlights investors’ growing preference for a disciplined and long-term approach to wealth creation.

Looking at fund performance, the data reveals that the top five large-cap MF schemes have delivered compounded annual average returns (CAGR) of between 15% and 20% over the past ten years. The Quant Focused Fund stands out with the highest CAGR of 20.44%. For comparison, gold investments made in 2014 yielded a return of approximately 97% with a CAGR of 7.2%, while the Nifty and Sensex delivered CAGRs of 13.4% and 12.6% respectively during the same period. Notably, large-cap MF investors earned a CAGR of 14.63% over the ten years of the PM Modi led BJP government.

Top 5 Large-Cap Mutual Funds by 10-Year Returns

Active vs. Passive Investing for Large-Cap Funds

The impressive gains from large-cap funds have led some investors to consider solely relying on index funds for large-cap allocation. While index funds offer a low-cost and convenient way to gain exposure to the broader market, the recent performance of actively managed funds presents a compelling case for a blended approach.

A recent SPIVA India Scorecard report highlights that half of the actively managed large-cap funds underperformed the benchmark S&P BSE 100 index in the previous year. This underperformance was even more pronounced over three and five-year periods. However, experts advocate for a strategic selection of funds, suggesting that a blend of actively and passively managed funds can deliver optimal returns, even with some overlap in the portfolio (around 30-40%).

Finding the Right Balance

The data presented in the above table highlights the significant difference in expense ratios between actively managed large-cap funds (around 1.5% to 2.5%) and passively managed funds like SBI S&P BSE 100 ETF (around 0.14%). This reinforces the importance of cost consideration when selecting funds.

Looking at the table, we can also observe the varied performance of different funds within the large-cap category. SBI S&P BSE 100 ETF delivered a stellar 32.49% return in the last year, given its lower expense ratio. Actively managed funds like Nippon India Large Cap Fund and SBI Bluechip Fund have delivered consistent returns over 5 and 10 years, showcasing the potential for outperformance by skilled fund managers.

Building a Diversified Portfolio with Active and Passive Funds

The rationale behind a blended approach lies in leveraging the strengths of both active and passive management styles. During strong market rallies, actively managed large-cap funds tend to outperform. Conversely, passive funds provide stability and predictability during volatile market conditions. A combination of active and passive strategies can be more prudent for investors seeking to maximize returns.

Key Considerations for Choosing Funds

When selecting funds, investors should consider their risk appetite and investment goals. Passive funds are generally better suited for risk-averse investors, as they offer predictable returns that closely mimic the underlying index. These funds typically come with lower expense ratios, further enhancing returns. Actively managed funds, on the other hand, can potentially deliver higher returns but come with inherent risks associated with the fund manager’s investment choices and higher expense ratios.

Here’s a breakdown of the key factors to consider for both passive and actively managed funds:

Passive Funds:

• Expense Ratio: Lower expense ratios directly translate to higher net returns for investors.

Actively Managed Funds:

• Expense Ratio: As mentioned earlier, higher expense ratios can erode returns over time. Therefore, prioritizing actively managed large-cap funds with lower expense ratios is crucial.
• Fund Manager’s Track Record: Investors should research the fund manager’s past performance and investment philosophy to assess their ability to outperform the benchmark.
• Sector Allocation: Analyze the fund’s sector allocation to ensure it aligns with your risk tolerance and investment goals.

Conclusion

The Indian MF industry has witnessed phenomenal growth, offering a plethora of investment options for investors of all risk profiles. While large-cap funds have delivered impressive returns, the debate between active and passive management persists due to current market and geopolitical situations. This article highlights the merits of a blended approach, where investors can leverage the stability of passive funds with the potential for alpha generation offered by actively managed funds. When constructing a portfolio, careful consideration of risk appetite, investment goals, expense ratios, and fund manager track record is essential to maximize returns and achieve long-term financial objectives.

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Disclaimer: This blog has been written exclusively for educational purposes. The securities mentioned are only examples and not recommendations. The information is based on various secondary sources on the internet and is subject to change. Please consult with a financial expert before making investment decisions.