Mutual fund
Where Can Active Funds Actually Add Value? The Rolling-Returns Evidence
A version of this article was published in Mint by our Founder & CEO.
Active versus passive is a hot debate in India, with zealots and profiteers on both sides. We have seen conflicting reports because they cherry-pick what is being compared (e.g., different benchmarks, period bias).
An equity investor already undertakes market risk. This is usually sufficient to meet their financial goals, all else being in order.
An investor can take market risk via Index Funds, which for a low cost replicate the benchmark stocks. Active funds, on the other hand, are professionally managed, higher cost funds that try to select a subset of stocks and aim to beat the market, or their benchmark.
With over 80% of equity AUM in India sitting in Active funds, most Indian investors are also taking another risk - the risk of fund selection. Is this fund selection risk worth it? We took a data driven approach to answer this.
We look at the distribution of 3,5,7 year rolling returns for all active funds for the period Jan 2013 to July 31st, 2026. Rolling returns reduce the end date bias inherent in trailing return based studies. A study end date towards the end of a bull market favours passive funds and an end date after a volatile/flat market favours active funds. This is because active funds in India tend to have a quality bias, underperform in bull markets and outperform in volatile/flat markets.
Each fund-period performance was compared to a theoretical index fund, derived as the fund's benchmark minus 0.2% p.a. - the cost of a typical index fund. A comparison with just the benchmark would have been an unfair post-fee vs pre-fee comparison. All categories use AMFI Tier-1 benchmark except large cap, which was benchmarked to a 80:20 Nifty 100 TRI and Nifty Midcap 150 TRI blend.
Where do passive funds have an edge?
Passives take the cake when the stock universe is narrow (100 to 150) and stocks are well discovered. In Large-cap and Mid-Cap categories, passive funds beat actives 54 to 70% of the time. A few hundred stocks, several thousand analysts - the efficient market hypothesis plays out. This is where India looks like a developed market and active fund underperformance stands out.
When the universe is ~250, but well researched - the Large&Mid Cap category, the result is a coin-toss. Neither active nor passive has an edge.
When does active management have a better chance?
When the universe is broader and less researched past the top 250 names, active management wins. Active funds win 57% to 65% of the time. Flexi-Cap, Focused and Value funds win but with a small margin - less than 1% annualized. Small Cap is the outstanding area for active management - Small cap funds beat their benchmark 90% of the time over a 7 year horizon.
The fine print
However, category averages do not paint a complete picture. The variance in returns among schemes in a category is problematic. It is far higher than the difference between active and passive funds. In flexi cap over seven years, the difference in CAGR between a 5th percentile and a 95th percentile fund is 10%. On ₹10 lakh invested, that is ₹9.1 lakh of gains against ₹25.5 lakh. Close to 3x the wealth created, from the same category over the same period. Thus, picking the right fund becomes extremely critical here.
Regular plans, in which the intermediary receives a commission, further reduces the gap. Data shows that the case for regular active funds is much weaker - even in the previously winning categories of Flexi, Focused and Value funds. Flexi cap goes from 63% to 47%, focused from 61% to 43%, value from 65% to 50%.
Active small caps funds have a consistently high alpha that can justify the commission cost. One note of caution though - the data is backward looking. Funds were small and information arbitrage was higher earlier in the study period. Things may change in the future and factors like AUM, market depth may impact small cap returns.
The Bottomline
Here is how investors can leverage this data into their playbook:
Build the core of the portfolio using Index Funds in Large cap & Mid cap categories or use active flexi cap funds.
Choose active funds wisely for satellite portfolio - especially in the small cap category.
Accept that your choice of active fund matters and be ready to research and monitor here.
And buy direct, because commission costs more than the average active fund manager adds to the returns.
Disclaimer: This story is for educational purposes only. We advise investors to check with certified experts before making any investment decisions.
