Mutual funds offer investors different ways to participate in financial markets, depending on how a scheme is managed. Some follow a market index, while others involve regular decisions by a fund manager. Active mutual funds are managed by fund managers who regularly suggest which securities to buy, hold, or sell. The approach involves ongoing analysis and portfolio decisions rather than following a fixed index composition. Understanding how these funds are structured and managed may help investors compare them with other mutual fund options and assess the factors that matter before selecting a scheme.
Meaning: How Actively Managed Funds are Different
The fund manager continuously researches the market and decides which investments to include in the fund. The manager selects securities, determines their portfolio weight, and may change the holdings based on the scheme's investment strategy.
The objective is generally to manage the portfolio with reference to a benchmark rather than simply replicate it. The fund manager generally assesses factors such as company fundamentals, valuations, market conditions, and sector trends while making portfolio decisions.
For example, an actively managed large-cap fund holds stocks of large-cap companies but may assign different weights to individual stocks than its benchmark index.
How Do Active Funds Work? A Step-by-Step Process
The following are the main steps involved in managing an active mutual fund.
1. Research and Security Selection
The fund manager and research team study securities based on factors relevant to the scheme. For equity funds, this may include financial performance, valuations, industry conditions, and company-specific factors.
2. Build the Portfolio
After research, the fund manager selects securities that fit the scheme's stated mandate. The selected securities are assigned different weights based on the portfolio strategy.
3. Monitor Market Conditions
The portfolio is reviewed as market conditions, valuations, economic factors or security-specific developments change. The manager adjust holdings within the scheme's permitted investment limits.
4. Rebalance the Holdings
The fund manager generally increase, reduce or replace securities when portfolio changes are required. The extent of such changes depends on the scheme's investment strategy.
5. Manage Portfolio Risk
The portfolio is monitored for factors such as concentration, volatility, credit quality and liquidity, depending on the type of fund.
6. Compare with the Benchmark
An active fund has a specified benchmark against which its performance is measured. Comparing the fund with its benchmark provides a reference for understanding how its portfolio has performed.
Key Features that Define an Actively Managed Portfolio
The following are key features of an actively managed portfolio.
- Professional Management: A fund manager manages the portfolio with support from research and investment teams.
- Active Security Selection: Securities are selected based on the scheme's investment strategy rather than simply following index weights.
- Portfolio Flexibility: Holdings and their allocation may change as the fund manager reviews the portfolio.
- Research-Based Decisions: Investment decisions often consider financial information, valuations, sector conditions, and other relevant factors.
- Benchmark Comparison: The fund's performance is compared with its specified benchmark.
- Portfolio Turnover: Active funds may change their holdings or portfolio weights more frequently than passive funds, although turnover varies considerably across strategies.
- Expense Ratio: Active management involves investment management and other operating expenses. These form part of the scheme's Total Expense Ratio (TER).
- Different Portfolio Exposure: Since the portfolio is actively managed, its holdings and weightings may differ from those of the benchmark.
Types of Active Mutual Funds in India
The following are common categories of active mutual funds in India, based on their asset class and investment approach.
1. Equity Active Funds
These funds invest primarily in equities and involve active selection of stocks. They include categories such as large-cap, mid-cap, small-cap, flexi-cap, and multi-cap funds, each following a defined investment mandate.
2. Debt Active Funds
These funds invest in debt and money market instruments such as corporate bonds, government securities, and Treasury Bills. The fund manager may manage factors such as credit quality, maturity, and portfolio duration.
3. Hybrid Active Funds
These funds invest across asset classes such as equity and debt. The fund manager manages the allocation between these assets according to the scheme's investment objective and stated strategy.
4. Value and Contra Funds
Value funds follow a value-oriented investment approach, while contra funds follow a contrarian approach. Both categories involve active security selection based on their respective investment strategies.
5. Growth-Oriented Funds
Growth-oriented strategies focus on companies or securities based on their growth characteristics. The fund manager selects investments according to the scheme's stated objective and portfolio mandate.
6. Equity-Linked Savings Schemes
Equity-Linked Savings Schemes (ELSS) are tax-saving mutual funds with a statutory three-year lock-in. Individual ELSS schemes may use active portfolio management, but ELSS is a separate scheme category rather than a general classification of active funds.
7. Sectoral and Thematic Funds
These funds focus on a particular sector or investment theme. Sectoral funds usually invest in areas such as banking or information technology, while thematic funds follow broader themes such as infrastructure or consumption.
Active mutual funds therefore cover several categories, with each scheme following a specific investment objective and portfolio strategy.
Advantages of Investing in an Actively Managed Fund
The following are some features of active management that investors may consider when comparing fund strategies.
- Active Security Selection: Fund managers usually select securities based on research instead of following the composition of an index.
- Portfolio Flexibility: The portfolio may be adjusted when the fund manager identifies changes relevant to the scheme's investment strategy.
- Different Investment Approaches: Investors may find active funds across several equity, debt, and hybrid categories.
- Research-Based Management: Active funds involve ongoing research and analysis of securities within the scheme's mandate.
- Scope for Portfolio Differentiation: The holdings and allocation of an active fund may differ from its benchmark.
- Professional Portfolio Management: Investment decisions are handled by a fund manager and supported by an investment team.
These features also involve additional costs and portfolio risks, so active management needs to be assessed alongside its limitations.
How to Evaluate and Choose an Active Mutual Fund
The following checklist covers important factors to review when evaluating an active mutual fund.
Check the Investment Objective
Read the scheme's investment objective and understand its permitted asset allocation, investment strategy, and risk factors.
Review the Fund Manager
Consider the fund manager's experience, investment approach, and the fund's management structure. Past performance alone does not determine future results.
Compare Benchmark Performance
Review the fund's performance against its benchmark across different periods. The comparison provides context for assessing the fund's performance.
Examine the Portfolio
Check major holdings, sector allocation, market-cap exposure, and portfolio concentration. These details provide a clearer view of where the scheme is invested.
Check the Expense Ratio
TER represents the recurring expenses charged to a mutual fund scheme. It is calculated as a percentage of the scheme's average Net Asset Value (NAV).
Review Risk Measures
Consider volatility, concentration, credit quality, and liquidity, depending on whether the fund invests in equity, debt, or multiple asset classes.
Understand the Plan Type
Direct and Regular Plans have the same underlying portfolio and are managed by the same fund manager. Their expense ratios differ because Direct Plans do not include distributor-related expenses.
Use a Simple Checklist
Before selecting an active fund, review:
- Investment objective
- Benchmark
- Portfolio holdings
- Fund manager
- Historical performance
- Expense ratio
- Risk measures
- Plan type
- Exit load, if applicable
Risks and Limitations You Should Know Before Investing
The following are key risks and limitations associated with active mutual funds.
- Market Risk: The value of the portfolio may fluctuate due to changes in market conditions.
- Managerial Risk: Investment decisions depend on the fund manager's research, judgement and execution.
- Benchmark Underperformance: An active fund may underperform its benchmark over certain periods.
- Higher Costs: Active management involves research, investment management and portfolio transactions, which may result in higher expenses than some passive funds.
- Portfolio Concentration: A fund may have significant exposure to particular companies, sectors or securities, depending on its strategy.
- Strategy Risk: The investment approach may perform differently across market conditions.
- Turnover Risk: Frequent portfolio changes may increase transaction-related costs.
- Tax Considerations: Tax treatment depends on factors such as the type of mutual fund, holding period, and applicable tax rules. Investors need to review the tax provisions applicable to their investments.
Active management therefore involves both flexibility and additional decision-making risk. The level of risk also differs across equity, debt and hybrid funds.
Who Should Invest in Active Mutual Funds?
Active mutual funds may be considered by investors who prefer professionally managed portfolios and want their investments to follow a strategy that differs from simply tracking a market index. They may also suit investors who are comfortable reviewing fund performance, portfolio changes, and the risks associated with active management.
1. Investors Seeking Potential Market Outperformance
Active fund managers actively select securities and adjust portfolio allocations with the objective of outperforming a benchmark index. Investors looking for the potential to generate excess returns may consider active funds.
2. Investors Who Prefer Professional Management
Active funds are managed by experienced fund managers who conduct research, analyze market trends, and make investment decisions on behalf of investors. This may appeal to individuals who do not have the time or expertise to manage investments directly.
3. Long-Term Investors
The benefits of active management may become more apparent over longer periods. Investors with a long-term investment horizon can allow fund managers sufficient time to execute their investment strategy.
4. Investors Comfortable with Fund Manager Risk
The performance of an active fund depends significantly on the fund manager's investment decisions. Investors should be comfortable with the possibility that the fund may underperform its benchmark or peers during certain periods.
5. Investors Seeking Exposure to Specific Opportunities
Active funds may be able to capitalize on market inefficiencies, sector opportunities, or changing economic conditions by adjusting portfolio holdings as needed.
Conclusion
Active mutual funds use professional portfolio management to select and manage securities according to a defined investment strategy. Their portfolios may differ from benchmark indices because fund managers have discretion over security selection and allocation. Active management is available across several equity, debt and hybrid fund categories in India. Investors evaluating these schemes should therefore review the investment objective, portfolio, benchmark, expenses, fund management approach and associated risks together.
FAQs on Active Mutual Funds
What is an active mutual fund in simple terms?
An active mutual fund is managed by a fund manager who selects and adjusts securities based on the scheme's stated investment strategy.
How is an actively managed fund different from a passive fund?
An active fund involves fund manager decisions, while a passive fund generally seeks to replicate the performance of a specified market index.
Are active mutual funds better than index funds?
Neither approach is universally superior. The comparison depends on factors such as strategy, expenses, risk, portfolio exposure and investment requirements.
Do active mutual funds always generate higher returns?
No particular outcome is assured. Performance may vary with market conditions, portfolio decisions, expenses, and differences between the fund and benchmark.
What is the typical expense ratio of active mutual funds in India?
There is no single expense ratio for active funds. TER varies by scheme, plan, asset size, and applicable regulatory limits.
What is the difference between a Direct and Regular plan in active mutual funds?
Both plans have the same portfolio, while Direct Plans exclude distributor expenses and generally have a lower expense ratio than Regular Plans.
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