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- What are Active Mutual Funds?
- Types of Actively Managed Funds
- Features of Active Mutual Funds
- Who Should Invest in Active Mutual Funds?
What are Active Mutual Funds?
Active mutual funds are a type of mutual funds where the fund manager plays an active role in deciding whether to buy, sell or hold the investments. Active funds employ a variety of strategies in order to construct and manage their portfolios. For example, to outperform the entire market and others acting as powerful hedges against unforeseen market declines or corrections.
The investing strategy and style are explicitly available in the Scheme Information document (offer document). Active funds seek to outperform their benchmark index in terms of returns. Furthermore, the fund strategy determines its risk and return characteristics.
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While some funds have a solid track record of producing stellar returns year after year, they frequently fail to outperform their underlying benchmark, posing an investment risk. Additionally, actively managed funds often charge higher fees to compensate the portfolio managers.
Types of Actively Managed Funds
An active mutual fund is constructed around a theme. The fund manager actively manages the portfolio by purchasing and selling underlying stocks in response to market conditions. Equity and debt mutual funds are actively managed funds. Index funds and ETFs are passive investments. These funds simply track the benchmark index and aim to generate similar returns.
Equity Mutual Funds
- Large Cap Funds: Large-cap mutual funds invest at least 80% of their assets in large-cap firms’ equity and equity-related securities.
- Mid Cap Funds: Mid-cap mutual funds must invest at least 65% of their total assets in mid-cap businesses’ stocks and equity-related products.
- Large and Mid-Cap Funds: Large and Mid-Cap funds invest at least 35% of the fund’s total assets in large and mid-cap companies, respectively.
- Small-Cap Funds: A minimum of 65% of the small-cap mutual fund’s total assets are invested in equity and equity-related securities of small-cap firms.
- Value Funds: Value funds follow a value investing strategy and invest a minimum of 65% of total assets in stock and equity-related products of value companies.
- Contra Funds: Contra funds take a contrarian approach to investing. The technique entails purchasing and selling in opposite (contra) direction to current market emotions. These funds invest at least 65% of their total assets in equities and equity-related products.
- ELSS Funds: ELSS funds invest at least 80% of total assets in equity and equity-related securities. ELSS investments qualify for tax deductions of up to INR 1.5 lakhs under Section 80C of the Income Tax Act, 1961 and have a three-year lock-in period.
- Multi-Cap: Multi cap funds invest at least 25% each in large, mid, and small-cap companies.
- Flexi Cap Funds: Flexi cap funds invests at least 65% of their total assets in large, mid, and small-cap companies
- Thematic/ Sectoral Funds: Sectoral funds invest 80% of total assets in a single industry, such as pharmaceuticals, automobiles, or information technology.
- Thematic funds invest in a theme. For instance, a fund dedicated to exports and services or infrastructure. Thematic funds invest at least 80% of total assets in equities and equity-linked products tied to a specific theme.
Debt Mutual Funds
- Overnight Funds: Overnight funds invest in debt securities that mature overnight. For example, t-bills, call money, certificate of deposits, etc., have a single day maturity.
- Liquid Funds: Liquid funds invest in highly liquid securities like T-Bills, call money, collateral borrowings (CBLO), certificates of deposit (CDs), and commercial papers (CPs). These securities have maturity of up to 91 days.
- Ultra-Short Duration Funds: Ultrashort duration funds invest in debt instruments with Macaulay duration between 3 to 6 months.
- Money Market Funds: Money Market Funds invest majorly into money market instruments like T-bills, CPs, and CDs with a maturity of up to 1 year.
- Short Duration Funds: Short duration funds invest in instruments with Macaulay duration between 1 and 3 years.
- Medium Duration Funds: Medium duration funds invest in debt securities with Macaulay duration between 3 to 4 years.
- Long Duration Funds: Long duration mutual funds invest in debt instruments with a Macaulay duration greater than 7 years.
- Dynamic Bond Funds: Dynamic bond funds invest in debt instruments across the different durations and adjust depending on the market scenarios.
- Corporate Bond Funds: Corporate bond funds invest across the highest-rated corporate bonds. The fund invests a minimum of 80% of the assets in AAA-rated bonds from established large companies.
- Credit Risk Funds: Credit risk funds invest a minimum of 65% of the total assets in corporate bonds with AA or A ratings.
- Money Market Mutual Funds: Money market mutual funds invest in highly liquid assets such as bonds, dated securities, CDs, T-bills, etc.
- Balanced Funds: Balanced funds are also known as hybrid funds. They invest in a mix of assets, such as bonds and stocks. The ratio of equity and debt is either fixed or variable. Usually, the ratio is 40:60 (equity: debt), with either of the two outweighing the other.
Features of Active Mutual Funds
Following are the key features of active mutual funds:
Investment Objective and Strategy
Active funds follow a strategy and curate a portfolio around it. The fund manager identifies securities that align with the fund’s strategy. In response to the market movements, the holdings are dynamically adjustable. Active mutual funds aim to outperform the broad market index (benchmark). For instance, a large-cap mutual fund aims to outperform its benchmark, the Nifty 50.
Fund Manager
The fund manager of actively managed mutual funds plays a significant role in the fund’s performance. They actively manage the fund composition at their discretion. There is a frequent rebalancing of the portfolio in response to the market movements or the fund management team’s research. Thus, the fund manager’s experience and his ability to select the right securities play an important role.
Expense Ratio
Like passive funds, active mutual funds are not low-cost investment options. Since there is active buying and selling of securities, the expense ratio is high, but subject to a regulatory cap. As a result, all the associated costs are much higher than a passive mutual fund. The expense ratio for active funds ranges from 0.5% to 2.5%, depending on equity or debt composition.
Portfolio Monitoring
Active funds require constant portfolio monitoring since their portfolio composition follows an investment objective. Thus, the fund manager has to actively buy and sell securities when the market fluctuates. Furthermore, these funds are less diversified than passive funds, and there is a possibility of bias towards any stock or industry.
Risk
Active mutual funds are market-linked instruments and thus are risky. Since the fund portfolio is actively managed, the fund is also exposed to fund manager risk. If the fund manager invests in highly risky or low performing assets, the fund returns may be lower. Thus, in comparison to passive funds that replicate their benchmark portfolio, active funds are riskier. Therefore, investors who are comfortable and understand the associated risks can invest in active mutual funds.
Who Should Invest in Active Mutual Funds?
Active mutual funds are suitable for investors who wish to invest in actively managed funds. In other words, the fund manager actively manages the portfolio of active mutual funds in order to keep up with the market fluctuations. Since the funds are actively managed, the experience and expertise of the fund manager play a very important role in the performance of the fund.
Furthermore, due to the frequent buying and selling of securities, active funds have a high expense ratio. Thus, while investing in active funds, you should consider the expense ratio as well as the fund manager’s profile.
The main motive of active funds is to outperform their benchmark. Hence the fund manager and their team of experts are always looking to identify securities that help generate significant returns for the investors.
Therefore, if you are an investor looking for benchmark beating returns, you can consider investing in active mutual funds. However, it is important to note that these funds are highly volatile, and thus you must have a good risk tolerance level.
