What are passive mutual funds?

A passive fund is a type of mutual fund that tracks market indices like Nifty or S&P BSE Sensex. The fund portfolio mirrors the index it is based on. Such funds typically seek to replicate the performance of the market (subject to a tracking error, which is the difference between the fund’s performance and that of its benchmark index).

This passive approach usually implies lower costs, because such funds do not involve frequent trading, and fund managers are not tasked with stock selection or management. This can make passive funds offer a cost-effective way to diversify investments.

Types of passive funds

Each type of passive mutual fund is designed to cater to different investment strategies and preferences. Some broad passive mutual fund types include:

Index fund These funds track the performance of a particular stock market index, like the Nifty or the Sensex. The portfolio comprises the same stocks in the same proportion as the index.

Exchange-traded funds (ETFs) ETFs also track an index but are traded like stocks on the stock exchange. They can be bought and sold at market prices throughout the trading day.

Smart beta funds: The fund portfolio mirrors that of strategy indices. Those indices choose stocks based on certain factors or characteristics such as value, quality, or momentum, rather than company size. Examples of strategy indices include Nifty Quality Low Volatility 30, Nifty200 Momentum 30 Index and Nifty200 Value 30.

Fund of Funds (FoFs):These funds invest in other mutual funds or ETFs, providing a way to gain exposure across various asset classes through a single investment.

Things to know about passive mutual funds

Here are some features and benefits of passive mutual funds:

Cost-effectiveness: Passive funds typically have lower expense ratios than active funds because the fund manager has a relatively limited role in portfolio design and management.

Market tracking: These funds aim to replicate the performance of a specific index. The investment performance, therefore, is aligned with broader market trends. This can be suitable for investors who want to mitigate the impact of a fund manager’s decision-making on their investment.

Risk management: Diversification across multiple securities helps spread risk.

Simplicity: They offer a straightforward investment approach, suitable for investors who prefer a hands-off investment strategy.

Factors to Consider Before Investing in a Passive Fund

Before investing in a passive fund, it is important to consider the following factors:

Define your goals: Identify your financial goals to pick the passive mutual fund that is suited to your needs. For instance, if you are saving for retirement, a home purchase, or another goal that is five-to-seven years away or more, equity-oriented passive funds may be better suited. These offer the potential to build wealth over time but can be volatile in the short term. Debt-oriented funds may be better suited for short-term goals, where relative stability of the invested capital is important.

Diversify your investments: Spread your money across different assets and regions using ETFs, index funds, and more, to reduce risk and aim for better long-term returns.

Assess your risk tolerance: Choose funds that match how much risk you can handle. By doing that, you are better able to deal with the ups and downs of the market.

Think long-term: Short-term market fluctuations typically do not have a significant impact on your investments when you have a long investment horizon.

Monitor and adjust: Regularly check your investments to ensure they are in line with your goals. Rebalance if needed to maintain your risk and diversification levels.

Considerations:

Investors should consider their investing objectives, risk tolerance, and preferences when deciding between passive and active funds. Mutual funds can captivate investors seeking active management and the prospect of outperformance, while passive funds are tailor-made for those pursuing broad market exposure at lower costs. Within a diverse investment portfolio, each choice has a different function.

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

This document should not be treated as endorsement of the views/opinions or as investment advice. This document should not be construed as a research report or a recommendation to buy or sell any security. This document is for information purpose only and should not be construed as a promise on minimum returns or safeguard of capital. This document alone is not sufficient and should not be used for the development or implementation of an investment strategy. The recipient should note and understand that the information provided above may not contain all the material aspects relevant for making an investment decision. Investors are advised to consult their own investment advisor before making any investment