Active vs Passive Mutual Funds: Best Investment Option for NRIs

Among investors, specifically for NRIs, who due to tax implications and market fluctuations in India, face different considerations, active vs passive mutual funds have remained a topic of debate. The founder of the Vanguard Group, John Bogle, in 1976, revolutionized the industry of mutual funds by launching the first passive index fund. Since then, the discussion has started about whether active or passive funds provide better returns.

To help you out, the blog will tell you about the key differences between them, pros and cons, and the best investment options for NRIs. So read on and gather all the information. 

What Are Active Mutual Funds?

In active mutual funds, funds are managed and monitored by the fund manager, appointed by the fund house. The fund manager constantly analyzes the individual stocks and market trends to decide which stocks to purchase, hold, or sell. These funds aim to beat their benchmark index constantly. 

Active mutual funds quickly adapt to the market conditions, which is beneficial during economic fluctuations. Additionally, compared to the market index, these funds have the potential for higher returns. However, as these funds are managed by experts, their cost is quite high. 

This was all about active mutual funds. Moving ahead, let's know how these funds work. 

How Do Active Mutual Funds Work?

The working of active mutual funds depends on the strategies of the fund manager. It includes in-depth qualitative and quantitative analysis. Based on the following information, these funds perform well:

• To generate alpha and perform more than the benchmark index, the fund manager conducts qualitative and quantitative research.
• The investment return and risk are completely dependent on the adopted style and investment strategy of the fund.
• Active mutual funds create a huge difference during market fluctuations.
• These funds are flexible and, compared to passive funds, know when to pivot into or out of the stock.

This is how active mutual funds work. Now, moving further, let's know about passive mutual funds. 

What Are Passive Mutual Funds?

Passive mutual funds with a strategy to purchase and hold a portfolio that monitors and tracks a specific benchmark index. Here, the fund manager does not play an active role in buying and selling bonds or stocks. These funds are cost-effective compared to active funds, the expense ratio is lower, and there are little to no transaction costs. 

Further, the passive funds are of two types:

Index Funds: These funds have a passive nature and imitate their respective benchmark indices. Additionally, these funds are without trying to outperform the index aim for constant performance. 

Passive Exchange-Traded Funds (ETFs): These funds are traded on the stock exchange and replicate their benchmark indices. Additionally, compared to traditional mutual funds, ETFs offer more liquidity and generally have lower expense ratios. Also, to invest in these funds, you need to have a trading or demat account.

This was all about passive mutual funds. Moving ahead, let's know how these funds work. 

How Do Passive Mutual Funds Work?

Passive mutual funds work on a buy-and-hold strategy. This limits the transaction costs and keeps the expenses lower. This structure of the passive mutual fund attracts NRIs seeking market-matching performance without paying high fees. 

Further, as mentioned above, in passive funds, the managers play a very passive and small role. Additionally, restrict themselves to purchasing and holding stocks. 

So, it is how passive mutual funds work. Moving further, let's know the key difference between active and passive funds. 

Key Difference Between Active and Passive Funds

The table below showcases the key differences between active and passive funds:

These were the key differences between active and passive mutual funds. Moving ahead, let's look at the pros and cons of both mutual funds. 

Pros & Cons of Active and Passive Mutual Funds

Here are the pros and cons of active and passive mutual funds:

Pros of Active Mutual Funds:

• Get the benefit of investing through technically sound and highly skilled professionals.
• During market disruption, the fund manager can help to exist and invest or hold in less volatile stocks.

Cons of Active Mutual Funds:

• These funds have higher costs because the fund manager is always trying to regularly stir the portfolio to stay updated with the market conditions. 
• Based on research, these funds invest in bonds or stocks; considering this, you cannot ignore the risk of their underperformance. 

Pros of Passive Mutual Funds:

• These are ideal investment options if you want to invest in the growth of India and want minimum benchmark returns.
• Compared to active funds, these funds are less expensive due to their lower expense ratio. It states that the expense won't take away the income from the fund.
• Stated that the fund manager does not play an active role in choosing the stock, the management risk is low.

Cons of Passive Mutual Funds:

• The scope of these funds is limited, and the fund manager has very little or no chance of doing an experiment in them. 
• Due to the difficulty of monitoring the benchmark index, with these funds, there is always a risk of tracking error. 

These were the pros and cons of active and passive mutual funds. Now, moving further, let's know among the two funds, which one NRIs should opt for investment. 

Active vs Passive Mutual Funds: Which One Should You Choose?

Opting between active mutual funds and passive mutual funds depends on several factors. It includes your risk tolerance, investment goal, financial goal, and investment horizon. Here to help you out, some conditions are mentioned that assist you in choosing the right investment.

Opt Active Mutual Funds If:

• Willing to pay a higher cost for higher returns.
• Trust the skills and experience of the fund manager and their capability to outperform the market.
• Your risk tolerance is higher, and comfortable with the underperformance of the market.

Opt for Passive Mutual Funds If:

• Prefer consistent market returns and lower cost.
• Seeking a simple hand-off approach with the aim of long-term investment. 
• In your investment, you value predictability and transparency.

These are some of the conditions that can assist you in choosing between active and passive mutual funds. Moving ahead, let's know how NRIs can invest in these funds. 

How NRIs Can Invest in Active and Passive Funds?

NRIs in Indian markets can legally invest in mutual funds. However, for investment, they need to fulfill a few rules and regulations. It includes completing your mutual fund KYC, along with adhering to the rules of the RBI, FEMA, and SEBI. Once you complete your KYC, you can invest in all the mutual fund schemes provided by AMCs via lump sum or SIPs. Mutual fund KYC is one of the mandatory requirements that you need to fulfill when you invest in mutual funds in India.

Further, the Securities and Exchange Board of India (SEBI) under the Prevention of Money Laundering Act (PMLA), 2002, has specified a set of regulations. It states that intermediaries and mutual fund houses, before they are ready to make investments, complete their due diligence on investors. 

This is how NRIs can invest in active and passive funds. 

Final Thoughts

Lastly, due to low cost and simplicity, the popularity of passive mutual funds over the years has increased. On the other hand, active mutual funds are a good option if you believe in the fundamental and technical analysis of the fund manager in investments. In active vs passive mutual funds, it totally depends on your financial goals, investment strategy, and risk tolerance, which is the best option for NRIs.

Furthermore, if you are still confused and looking for reliable NRI investment guidance, connect with Savetaxs. We have a team of financial experts who help you choose the best investment option as per your goals. So, contact us today and begin your investment journey in India with clarity and confidence.