5 Myths about passively managed mutual funds

Ever since childhood, everyone must have been at the receiving end of the command ‘Active ho jaao’. After all, being passive or sitting and doing nothing was always considered a sign of laziness. However, this is no longer the case and passive mutual funds will tell you why.

Across developed markets, passively managed mutual funds are one of the top categories for investment. This is because they offer you an opportunity to participate in the growth of the market, without actually having to research or track equities on a daily basis. Further, passively managed mutual funds charge a relatively lower commission, since they do not need to be actively managed and tracked by the fund manager. These are some major traits of passive funds which make them extremely appealing. The trend is yet to gain strong traction in India but, as the market matures and retail investors start considering multiple avenues of investment, passive funds are set to explode. If you are also thinking of investing in passively managed mutual funds but worry about some of the things you have heard, here are five common myths that need to be busted.

1. Passive funds don’t offer high returns

There is a common myth that index funds, one of the most popular types of passive funds, do not offer returns at par with other fund types. One reason why people believe this revolves around the active management strategy followed by other funds. You may think that, because an active fund manager is constantly buying and selling investments in order to capitalise upon every market opportunity, the return generated will always be higher than the market. However, this is not strictly true, especially over the long run, as it is nearly impossible to beat the market consistently. With passive funds, you will earn returns at par with the market, while shelling out a minor amount for fund management.

2. There is not much variety available

Once upon a time, there were few passive funds available for investing and these were mostly index funds. However, this is not true anymore. Almost all of the major fund houses offer a variety of attractive index funds and these are benchmarked against all the popular indexes, including the Sensex, the Nifty, as well as international indices like the S&P and the Nasdaq. More importantly, today you also have the option to invest in debt passives like target maturity funds that follow a particular bond index. All you have to do is choose the option best suited for your requirements.

3. The ETF vs Index fund confusion

Some people are of the opinion that exchange traded funds are better than index funds, especially because of its lower price. However, when you invest in ETFs, you still have to pay the brokerage fee, the securities transaction tax or STT, the charges incurred by your demat account, as well as the liquidity cost. Further, you cannot attain the benefit of systematic investment plans, when investing in ETFs, but you can do so with index funds.

4. Experienced investors should not invest in passive funds

While it is true that passive funds are an excellent option for first-time and inexperienced investors, the opposite is not necessarily true. You can continue to invest in passive funds, even after gaining experience, if you are keen on participating in the market’s growth, without putting in the hard work. Passive funds are perfect for everyone keen on investing, without putting in the effort required to study or track the market.

5. Returns on passive funds will be absolutely aligned with the market

Yes, passive funds do track the underlying index but this does not mean that the returns will be symmetrical. This is because most funds show a tracking error, when benchmarked against the index. This is a standard deviation seen in the difference in returns between the fund and its benchmark index but it is advisable that you pick funds that have the least possible deviation.

Over time, passive funds do have the potential to offer strong long-term returns with the added advantage of lowering portfolio volatility. So, if you are considering investing in passive funds, do not get dissuaded by these common myths.

An investor education initiative by Edelweiss Mutual Fund

All Mutual Fund Investors have to go through a one-time KYC process. Investors should deal only with Registered Mutual Fund (RMF). For more info on KYC, RMF and procedure to lodge/redress any complaints, visit - https://www.edelweissmf.com/kyc-norms

MUTUAL FUND INVESTMENTS ARE SUBJECT TO MARKET RISKS. READ ALL SCHEME-RELATED DOCUMENTS CAREFULLY