Retail investors have the option of either adopting an active investing strategy or a passive investing strategy. An active investment strategy involves an investor investing in a fund where stocks are actively picked by the fund manager and is involved in trading the underlying securities daily to help the scheme achieve its investment objective. Passive investment strategy involves an investor investing in a fund that doesn’t have an active stock selection and may offer lower returns.
Depending on whether you are an active investor or a passive investor, you may decide to invest either in an equity fund or an equity index fund. The two may sound similar but adopt a different investment approach.
Let us understand the difference between these two types of mutual fund schemes.
Equity funds are open ended equity schemes that invest a majority of their investible corpus in equity and equity related instruments of companies that are publicly listed in India. Equity funds invest in stocks of various companies and try to generate returns by building a diversified investment portfolio. These mutual funds may invest spread the overall investment risk by spreading the investible corpus across market capitalization and in different sectors and industries.
Equity index fund
While equity funds have designated fund managers who actively buy and sell securities to help the fund generate returns, index funds are passive funds that aim at generating capital appreciation by mimicking the performance of its underlying index. They invest in stocks of its underlying index in the same proportion as the index.
Difference between equity funds and index funds
|In case of equity funds, they have a designated fund manager who uses his years of industry experience to analyze and make active investment decisions on behalf of the fund.
|As mentioned earlier, index funds do not have any kind of active participation of a fund manager, they simply replicate the performance of their underlying fund.
|Equity funds offer active risk management and since they are active funds, their expense ratio is relatively high
|Since there is no active participation of the fund manager and the fund follows a passive investment strategy, the expense ratio of owning an index fund is relatively lower
|The reason equity funds have a high expense ratio is because here fund managers have to work with a team of analysts and market researchers to build a basket of securities and have to actively buy and sell them to help the scheme achieve its investment objective.
|The reason for index funds to have gained popularity among Indian investors is because they have a very low expense ratio as compared to passive funds
|The performance of an equity fund highly depends on how its fund manager trades its underlying securities and generates capital appreciation
|Index funds too have fund managers, but they only reshuffle the investment portfolio from time to time. An index fund tracks the performance of its underlying securities by investing in the same proportion as the securities are invested in the underlying index