Have you heard about Index Mutual Funds? Are you aware of the concept? We have discussed the same below Active Fund Mutual funds are distinguished into ‘active funds’ and ‘passive funds. Active are those funds where fund manager plays a bigger role to ensure that the fund earns more than the set benchmark. For example, most equity funds will have either the Sensex or the Nifty index as benchmarks. The fund managers believe they have the ability to select stocks and time the market in a manner that makes the returns on their portfolio higher than what the market gives over a specific period of time. Passive Fund Passive funds are also called as ‘index fund’s. And as it goes by name, the only aim of these funds is to mimic an index. These funds invest only in scrips that are a part of the index and in exactly the same proportion as they are in the underlying index. For example, a passive fund on the Nifty index will buy all 50 stocks in the Nifty in the same proportion as are held by the Nifty. Each time a stock is taken out from or added to the index, the fund will do the same. On a day-to-day basis, this makes lesser work than managing active funds. Investors can expect almost the same return as the index though there will be a small difference between an index fund’s performance and that of its benchmark. This is called tracking error because of the various cost it incurs (brokerage, advertising, marketing, etc.) and the small cash component that every index fund keeps to meet redemptions. Should you select ACTIVE OR PASSIVE Funds? The costs in a passive fund are lower than an active fund due to the lower churning of the portfolio and no research required to run such a fund. Typically Index Funds have a fees of 1% of the Assets Under management(AUM). The fees charged by Active Funds vary from 1.50% to 2.25%. As an investor, you need to see if the higher expenses are justified by higher returns from the Active fund because over a long period the higher expense ratio can have a large impact on your returns. The level of risk in investing differs from one fund to another based on their investment objective. Active funds are more risky compared with passive funds since you are taking the risk of a fund manager taking stock calls that may go wrong. Within index funds also, funds mimicking broader indices are less risky than those that mimic a sector or a market segment. For example, the risk is lower in a Nifty Index compared with an index on the Banking Index or the Junior Nifty. Passive Funds (Index Funds) are best suited for the risk-averse investor. However, the clearest disadvantage of passive management is that at times, even if you do not want to participate in a particular stock or sector, you end up participating by investing in the index funds. In an emerging market like India, passive funds may not be the best of the options as many Active Mutual Funds have consistently outperformed the underlying index in the past 15 years. One may, however, consider having an Index Fund in his portfolio to reduce the overall volatility.