By Natika Poddar

While the 30-share S&P BSE Sensex captures new heights, the broadmarkets have remained subdued. This has propelled many investors to think whether they should go for active or passive investments in the equity markets.

In active management, the fund manager manages the fund to generate returns above the underlying benchmark indices. The fund manager and his research team tracks various stocks, sectors of the economy and takes technical calls based on price action. On the other hand, in passive investments the fund manager looks to replicate the returns of the tracking indicies. The returns are in line or below the benchmark indicies. Moreover, in passive investments, no alpha is generated and an investor is assured of the returns in line with the benchmark indices.

Active investments

In active investments, the fund manager actively tracks the markets, identifies the stocks and sectors and times his buy and sell. In the process, the fund manager generates the much-required alpha returns during the period of investments.

Active investments are short-term in nature wherein passive investments are long-term in nature. Active investments do not follow a specific index. Investors can buy, diversify stock from the market which are doing well. Active investments use hedge put-and-call strategies and options to reduce risk.

Also, tax management can be done by selling investment which are loss-making and offsetting the tax by showing loss in income tax returns.

Active investments are costlier than passive investments as the fund manager will charge a higher fee for managing the fund. They are also risky investments as a fund manager can take a wrong call on stocks picking, which may bring down the returns. So, one must choose a fund which has experienced fund managers.

Passive investments

Passive investors follow the markets with long-term investment objective. The cost of investing is lower in passive investments as compared to active investments. As fund managers in passive investors invest in indexed funds, there is transparency in investment. In passive investments, returns are generated through dividends and capital appreciation spread over the investing period. An investor must periodically monitor the performance of the fund or stock.

Passive investments are tax efficient as investors buy-and-hold the stock. It does not result in a massive capital gain tax for a particular financial year. Being long-term, investors gain in capital appreciation. However, there are drawbacks, too. Passive investments are restricted to a specific index or pre-determined set of investments with little or no change in investment portfolio. Investors are locked into those holdings no matter what happens in the market.

Ideally, those whose are looking to invest with a three- to five-year horizon for a particular goal should invest in a disciplined manner through Systematic Investment Plan (SIP) of mutual funds.

In fact, in November while net equity inflows crashed to Rs 1,312 crore, the lowest since June 2016, collections through SIPs hit an all-time high of Rs 8,273 crore. To be sure, the mutual fund industry added five lakh SIP accounts in the month and it is the twelfth consecutive month where SIP inflows were over Rs 8,000 crore.

Overall, if one is deciding between active and passive investing, a blend of both is advisable. In such a blend, an investor can not only reap good returns but can also reduce the portfolio risk.

The writer is associate professor, Finance, St. Francis Institute of Management and Research, Mumbai