Understanding Active and Passive Investment Approaches

The comparison between active vs passive mutual funds begins with how the portfolio is managed. Active funds rely on fund manager decisions and security selection, while passive funds follow a predefined benchmark. Costs, manager dependence, benchmark exposure and the role of the fund within the portfolio can help investors evaluate the two approaches.

India's mutual fund assets under management increased from approximately ₹12 lakh crore in 2015 to ₹79 lakh crore by September 2025, according to the SEBI Investor Survey 2025. As the mutual fund market has expanded, investors have access to funds following different portfolio-management approaches. (Source)

Active and passive investing represent two such approaches. Understanding how each strategy works can help investors assess which type of fund aligns with their financial goals, risk profile and portfolio requirements.

Active vs Passive Mutual Funds: What Actually Changes?

The difference between active and passive mutual funds goes beyond whether a fund manager selects stocks. The investment approach also affects how the fund is evaluated, the role of the benchmark and the factors investors may consider before selection.

Neither approach is inherently suitable for every investor. The relevance of each can depend on what exposure the investor requires and how the fund fits within the overall portfolio.

What Should Investors Evaluate Under Each Approach?

1. Manager Dependence

With actively managed mutual funds, portfolio outcomes can be influenced by security-selection and allocation decisions made according to the fund's investment strategy.

Investors can therefore assess the fund manager's tenure, investment philosophy, portfolio construction and consistency across different market conditions.

Passive funds reduce dependence on discretionary security selection because their portfolio is linked to a predefined benchmark. However, this does not remove the potential risks associated with the underlying securities.

2. Costs

Both active and passive funds charge expenses, although the cost structures can differ.

Active management may involve research and portfolio-management activities that can contribute to relatively higher expenses. Passive funds generally require less discretionary portfolio management, which can result in relatively lower costs.

However, cost alone does not determine whether a fund is suitable. The investment objective, underlying exposure and other scheme characteristics should also be considered.

3. Return Expectations and the Benchmark

Active funds may seek to generate performance relative to a stated benchmark through portfolio decisions. Such decisions can result in either outperformance or underperformance depending on the fund strategy and market conditions.

Passive funds seek to provide returns broadly aligned with the index they track, subject to expenses and tracking differences.

Therefore, an index funds vs actively managed funds comparison should not assume that either approach will necessarily generate higher returns.

4. How the Fund Should Be Evaluated

The evaluation criteria also change with the strategy.

For an active fund, investors can consider:

• fund manager experience and tenure;

• investment philosophy;

• portfolio construction;

• consistency across market conditions; and

• expense ratio.

For passive mutual funds, investors can consider:

• underlying benchmark;

• tracking error and tracking difference;

• expense ratio;

• portfolio replication; and

• AUM.

The focus should remain on factors relevant to the strategy rather than applying the same selection criteria to every fund.

Do Investors Need to Choose Only One Approach?

Active and passive funds can coexist within an investment portfolio.

For example, an investor may use a passive fund for exposure to a broad market benchmark and an active fund for a different category or investment strategy. However, holding both does not automatically improve diversification.

The underlying holdings, asset allocation and potential portfolio overlap should be reviewed to understand whether each scheme serves a separate purpose.

How Do I Decide Between Actively Managed and Passive Mutual Funds?

The decision can start with a few questions:

• Investment Objective: What type of market exposure or investment strategy am I seeking?

• Manager Dependence: Am I considering a strategy that relies on active security-selection decisions?

• Benchmark Preference: Do I want exposure designed to follow a specified index?

• Cost Consideration: How do the scheme expenses compare with the investment approach?

• Evaluation Requirements: Am I prepared to assess an active investment process or would I prefer to evaluate benchmark tracking?

• Portfolio Fit: Does the fund add a distinct exposure to my existing portfolio?

These factors can help investors compare active vs passive investing in India without assuming that one strategy is universally preferable.

Also Read: Active Funds or Passive Funds? Why not Both!

Common Mistakes When Comparing Active and Passive Funds

The distinction between active and passive management should be considered alongside the characteristics of the individual scheme. Some common mistakes include:

• Choosing Only on Past Returns: Historical performance may not continue under different market conditions.

• Assuming Passive Funds Are Risk-Free: Passive funds remain exposed to risks associated with the benchmark and underlying securities.

• Comparing Costs in Isolation: A lower expense ratio does not by itself determine investor suitability.

• Ignoring the Benchmark: The benchmark determines the exposure that a passive fund seeks to replicate.

• Adding Both Without Checking Overlap: Active and passive funds can hold similar securities and create overlapping exposure.

Blog Disclaimer

The information herein is meant only for general reading purposes and the views being expressed only constitute opinions and therefore cannot be considered as guidelines, recommendations or as a professional guide for the readers. The document has been prepared on the basis of publicly available information, internally developed data and other sources believed to be reliable. Recipients of this information are advised to rely on their own analysis, interpretations & investigations. Readers are also advised to seek independent professional advice in order to arrive at an informed investment decision.

SEBI Registration No. MF/020/94/8

Mutual Fund investments are subject to market risks, read all scheme related documents carefully.