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Active fund managers charge 1 to 1.5% to beat the index. Index funds charge 0.1% to be the index. The case for passive investing has been screaming for years. So why do active funds still exist?
Because they actually win in some places. Just not where you’d expect.
Let’s start with where passive wins clearly.
The case for passive in large caps
In Indian large-caps, the data is brutal for active managers. Over 5-year periods, a majority of active large-cap funds underperform the Nifty 50 after fees. The market is efficient, the analysts cover the same 50 companies, and there’s not much edge to be found. A Nifty 50 index fund at 0.1% expense ratio beats the average active large-cap fund at 1.5%, year after year, mostly through cost alone.
If your large-cap exposure is in active funds, switch. The math is settled.
Where it gets more interesting is in mid-caps and especially small-caps.
Why active still works in small and mid
Small-caps have around 1,000 listed companies that very few analysts cover. Information is uneven. Mispricings are common. A skilled small-cap manager who actually does the research can find stocks the index doesn’t capture. The data shows mid and small-cap active funds outperform their indices about 40 to 50% of the time over 5 years, which sounds bad until you remember that’s roughly twice the active large-cap success rate.
The catch. Picking the right active small-cap fund matters enormously. Top quartile small-cap funds beat the index by 4 to 6%. Bottom quartile ones lose by 4 to 6%. The dispersion is huge.
The fee math that decides outcomes
If passive costs 0.1% and active costs 1.5%, the active fund needs to outperform by 1.4% just to break even. In large-caps, that’s a tall order. In small-caps, it’s achievable.
Sector funds: a different question
Sector funds are a different question. They’re passive in the sense that they track a sector. They’re active in the sense that you’re actively betting on a sector. Their place in your portfolio is for tactical tilts, not core allocation.
A sensible build-out for HENRYs.
Core large-cap exposure through index funds. Cheap, broad, hard to beat. About 30 to 40% of your equity.
Mid and small-cap exposure through carefully chosen active funds. The dispersion makes manager selection matter. About 30 to 40% of your equity.
Sector or thematic tilts in active funds where you have conviction. Maybe 10 to 20%.
The remaining international, gold, and tactical bits are different conversations.
Building a hybrid that uses both
The active vs passive debate isn’t a moral question. It’s a market efficiency question. In efficient markets, passive wins. In inefficient ones, skilled active wins. India has both.
