Active Vs Passive Mutual Funds: Which Is Better For NRIs & OCIs?

John Bogle (founder of Vanguard Group) revolutionized the mutual fund industry by introducing the first passive index fund in 1976.

In the mutual fund literature, there is a long-standing discussion between investors over the selection of active / passive mutual funds.

There is a good amount of research evidence indicating why one should opt for passive funds over active funds.

However, you can see analysts and research scholars arguing how a large cash-inflow into passive funds can increase bid-ask spreads.

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What Are Active Mutual Funds?

Active mutual funds are funds in which the fund house appoints a ‘fund manager’ to actively manage the funds.

Here, the fund manager is vested with a responsibility to decide which stocks to buy, hold, or sell.

‍Active funds aim to beat their benchmark index on a constant basis.

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How Do Active Mutual Funds Work?

Active mutual funds are the adaptation of their fund managers' strategies. These funds perform well based on the following information,

• An active fund manager indulges in qualitative and quantitative research to generate alpha and outperform the benchmark index.
• The risk and return are completely based on the investment strategy and style adopted by the fund.
• Active funds can make a huge difference when the market is in turmoil. 
• Active funds are ‘flexible’ and know when to pivot into or out of the stock when compared to passive funds.

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Should NRIs and OCIs Invest In Active Mutual Funds?

If you are an NRI or OCI planning to invest in active funds, the following information can come in handy,

• By opting for active funds, you will have the advantage of investing through highly skilled and technically sound professionals.
• During market upheaval, active fund managers can guide the fund to exit and hold or invest in less volatile stocks.

Also, you might have to deal with the following cons if you invest in active mutual funds,

• The active funds tend to have higher costs because the fund manager tries to regularly churn the portfolio to stay ahead of the market. 

• Active funds invest in stocks or bonds based on research and you cannot ignore the risk of these stocks underperforming.

For NRIs managing investments from the U.S., having access to Indian banks in the country is crucial. Check out our guide to Indian bank branches in the USA.

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What Are Passive Mutual Funds?

Passive mutual funds hold a portfolio that tracks and replicates a particular benchmark index with a strategy to buy & hold.

Here, you won’t find any active involvement by the fund management in buying and selling of stocks or bonds.

Passive mutual funds are cost-effective as the expense ratio is lower than an active fund and little to no transaction costs.

The passive mutual funds are of two types, namely,

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Index Funds

Index funds are passive in nature and replicate their respective benchmark indices. 

These funds aim to earn similar returns to benchmark index unlike active funds that look to outperform its benchmark index.

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Passive Exchange Traded Funds (ETFs)

Passive ETFs are traded on the stock exchange and replicate their respective benchmark indices.

You need to have a demat or trading account to invest in Exchange Traded Funds.

Generally, these funds come with better liquidity and lower expense ratio than an index fund.

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How Do Passive Mutual Funds Work?

The passive mutual fund adopts a passive investment strategy and aims to mimic a specific benchmark index. 

These funds mimic the index and invest in the same stocks in similar weightage.

Here, the fund managers play a very minimalistic and passive role and largely restrict themselves to buying and holding stocks.

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Should NRIs and OCIs Invest In Passive Mutual Funds?

Passive funds can be an ideal choice for you for the following reasons,

• If you wish to invest in India’s growth and want at least benchmark returns. 
• Passive funds are relatively cheaper due to their lower expense ratio, which suggests that expenses won’t eat away the fund's income.
• Given that no active fund manager is involved in picking the stocks, the management risk is low.

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However, you need to be aware of the following cons before investing,

• The scope of passive funds has a limit and the fund manager has little to no chance for experimentation.
• With passive index funds, there is always a risk of tracking error due to the difficulty of tracking the benchmark index.

Note: Tracking error showcases the annualized difference between the index fund and its benchmark index returns.

Here’s our blog on How Should NRIs Select Equity Mutual Funds in India? This can help you pick the right fund for investment.

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Active Mutual Funds Vs Passive Mutual Funds: Key Differences 

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Conclusion

Over the years, the popularity for passive mutual funds has grown substantially due to its simplicity and low cost.

On the other hand, active fund managers constantly strive to outsmart the market indices. 

If you are looking to invest for the long-term in low cost funds, then passive mutual funds can be your go-to option.

You can consider investing in active-funds, if you believe that a fund manager’s technical / fundamental analysis can make a difference.

Moreover, by accessing iNRI’s AI-powered Smart Investing Tool, you can diversify your investment portfolio. Further, iNRI portfolio rebalancing strategies can help you earn better risk adjusted returns.

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Active Vs Passive Mutual Funds: Frequently Asked Questions (FAQs)

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What is the major difference between active and passive mutual funds?

In active mutual funds, you will find the fund manager’s active involvement in deciding which security to buy / hold /sell. 

On the contrary, passive mutual funds might require little to no monitoring or scrutinization.

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What is passive investing?

Passive investing is the strategy of replicating its benchmark index like Nifty50 or Nifty midcap 150 to earn similar returns.

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How to invest in passive mutual funds?

As an NRI, investing in passive mutual funds is now easy and simple.

All you need to do is create an iNRI account and validate your KYC details.

Pick a suitable fund from the list of funds that are specifically curated based on your country of residence and invest.

Here’s how iNRI’s Investment approach works. For NRIs comparing mutual funds with other investment options like Portfolio Management Services (PMS), this guide can provide further insights.

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Are mutual funds actively or passively managed?

Mutual funds can be actively or passively managed. 

You can access the fund’s offer document containing essential details related to the mutual fund scheme.

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Is active investing high risk?

Active investing can be of high risk when compared to passive investing.

Active fund aims to generate alpha by outperforming the benchmark index which requires the fund manager to take risks.

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