What are passive Mutual Funds?
In recent years, there has been a considerable shift in investing trends. One of which is focused on passive funds. They require lesser portfolio changes or management costs and are often less expensive than active investments. As a result, many long-term investors use passive investments to build wealth.
Let's dive in deeper to learn more about passive mutual funds.
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What is a Passive Mutual Fund?
A passive fund is a fund that creates an investment portfolio by tracking a market index or a specific market segment. Unlike active funds, the fund manager is not required to conduct extensive research to identify the stocks as a part of the portfolio. As a result, a passive fund is a low-cost investment option.
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The fund manager replicates the index composition. The main aim is to create a benchmark portfolio with minimum tracking error. Therefore, the returns are quite close to the overall market returns.
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For instance, a fund tracking the BSE Sensex will have the same 30 stocks in its portfolio. Similarly, if a fund mimics Nifty, the fund's portfolio will have the same 50 stocks that are part of the Nifty index. Moreover, the stock weights are similar to the index holdings.
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There
are two types of passive mutual funds:
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Index
Funds
Index funds mimic the underlying benchmark index. The fund manager's job is to replicate and maintain the underlying benchmark's portfolio. The main focus can be market cap, sector, theme or a broad market index.
The funds' returns are closely similar to the benchmark. However, there may be variance in performance due to a tracking error.
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Exchange Traded Funds (ETFs)
Exchange-traded funds (ETFs) are funds that track the performance of an underlying index. The portfolio of an ETF closely resembles an Index.
The underlying stocks in the portfolio determine the value of the net assets. Furthermore, ETFs trade on the stock exchange; thus, one can even buy and sell ETFs through the stock exchange platform.
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Following things, you should know about passive mutual funds:
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Investment Strategy
“Buy and hold” is the core strategy of passive mutual funds. Since the composition mimics the benchmark index, the fund manager is not required to optimise the portfolio much. This makes passive mutual funds low-cost investment options. Additionally, passive funds recruit various investment strategies, such as tracking sector indexes, broad market indexes, etc.
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Returns
Passive mutual funds aim to closely replicate the benchmark index like the Nifty or Sensex or any other index. In other words, the stock representation of the passive mutual fund and the portfolio composition will be similar to the underlying benchmark. Moreover, the returns from passive funds may be close to the market returns. The gains from passive funds are also compounded over the investment horizon, making them suitable for the long run.
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Risk
Passive mutual funds are market-linked instruments and, therefore, a risk. The portfolio is well-diversified due to the replication of the benchmark index.
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Portfolio
Since portfolio composition replicates the underlying benchmark, passive funds are widely diversified.
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Fees
Generally, Passive funds are low-cost investment schemes that do not involve the active buying and selling of securities. As a result, all the costs associated with the fund are low compared to an active mutual fund.
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Conclusion
If you are aiming for long-term wealth creation, passive funds can be your next investment alternative. That’s not all. If you’re a beginner looking to choose the right fund, passive funds may be a good entry point for your step into the market.
Understanding Passive Mutual Funds
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