When people start investing through mutual funds, the first advice they usually hear is about discipline. Invest regularly through an SIP, stay invested through market ups and downs, and let compounding do its work.
Discipline certainly matters. But there is another factor that is just as important and often overlooked — structure.
Two investors may both run SIPs for years with equal discipline, yet their portfolios can grow very differently. The reason is simple: the category of funds they invest in and the investment approach those funds follow.
This is why understanding how a fund is structured and evaluated becomes crucial.
How Do We Know If a Fund Has Performed Well?
When we look at mutual fund returns, the first instinct is to see whether the fund has delivered high returns. To judge whether a fund has actually done a good job, we need a reference point.
This reference point is called a benchmark.
A benchmark is simply the market’s average return for a specific segment. It represents how that part of the market has performed overall.
For example, if you want to understand how large companies in India have performed, you could look at an index like the Nifty 100, which contains the top 100 companies by market capitalisation. Instead of analysing each company individually, the benchmark gives you a quick picture of the entire segment.
Every mutual fund category is compared against a relevant benchmark.
Understanding Mutual Fund Categories
Mutual funds are broadly divided into categories based on the size of companies they invest in.
Large-cap funds invest in Companies in the Top 100 stocks by market capitalization, the biggest and most established companies.
Mid-cap funds focus on companies that are ranked 101st to 250th by market capitalization, growing and expanding.
Small-cap funds invest in smaller companies ranked 251st and beyond by market capitalization, with higher growth potential but also higher volatility.
Flexi-cap funds have the flexibility to move across large, mid, and small companies depending on market opportunities.
Each of these categories has its own benchmark that represents the market return for that segment. Once you understand benchmarks and categories, another important distinction becomes clearer.
Within every category — large cap, mid cap, small cap, or flexi cap — you will usually find two types of funds.
Some funds aim to Meet the benchmark.
Others aim to beat the benchmark.
This is where the idea of active and passive investing comes in.
Active vs Passive Investing: What’s the Difference?
- Passive investing aims to Meet the benchmark.
A passive fund simply tracks an index. If the index rises by 10%, the fund will deliver roughly the same return. The strategy requires very little intervention and therefore costs less.You can think of passive investing like ordering a ready-made meal from a well-known restaurant. The recipe is standardised, the outcome is predictable, and the cost is relatively low. - Active investing works differently.
An active fund manager studies companies, analyses sectors, and makes decisions about which stocks to include in the portfolio. The objective is not just to follow the benchmark but to outperform it.This approach is similar to hiring a personal chef who carefully selects ingredients and adjusts the recipe to create something better than the standard menu. It costs more, but the goal is a superior result.
Which brings us to the natural question.
If active funds charge higher fees, do they actually deliver higher returns after those fees?
To answer that, we need to look at real data.
Do Active Funds Actually Add Value?
Different mutual fund categories are assigned specific benchmarks. Large-cap funds may be measured against the Nifty 100, while small-cap funds may be compared with the Nifty Smallcap 250.
For active funds, the key measure is how much they can outperform their benchmark. This difference between the portfolio return and benchmark return is called alpha.
Below is a comparison of the top five active funds in each category over the past five years.
| Category | Top 5 Average Return | Benchmark | Alpha |
|---|---|---|---|
| Flexi Cap | 18.82% | 14.49% | 4.33% |
| Small Cap | 22.75% | 19.23% | 3.52% |
| Large & Mid Cap | 19.09% | 16.86% | 2.23% |
| Large Cap | 14.88% | 12.82% | 2.06% |
| Mid Cap | 22.05% | 20.77% | 1.28% |
| Multi Cap | 17.83% | 16.56% | 1.27% |
Flexi Cap funds stand out in this comparison. The top five funds delivered an average return of 18.82%, comfortably ahead of the benchmark’s 14.49%, generating an alpha of 4.33% annually over five years.
At first glance, 4.33% may not seem dramatic. But remember that this is the extra return generated even after deducting fund expenses.
In simple terms, investors paid the fund manager’s fees and still ended up earning more than the benchmark.
What Does This Difference Mean in Practice?
Let’s take a simple example.
Suppose ₹10 lakh was invested for five years.
At the benchmark return of around 14.49%, the investment would grow to roughly ₹19.7 lakh.
At the active fund return of around 18.82%, the investment would grow to approximately ₹23.7 lakh.
That’s nearly ₹4 lakh of additional wealth created over five years.
This is the important point. The fee paid to the fund manager was not a cost without benefit. It was the price paid for generating additional returns.
If a fund merely matches the benchmark, the fee may feel unnecessary. But if it consistently beats the benchmark after fees, the fee becomes an investment in expertise.
Is This Outperformance Just Luck?
Another question investors often ask is whether this outperformance is just a one-time event.
When we examine mid-cap funds across different time periods, the pattern suggests otherwise.
| Period | Top 5 Avg | Benchmark | Alpha |
|---|---|---|---|
| 1 Year | 23.11% | 18.68% | 4.43% |
| 2 Years | 15.26% | 10.26% | 5.00% |
| 3 Years | 26.67% | 24.88% | 1.79% |
| 5 Years | 22.05% | 20.77% | 1.28% |
Across multiple time frames — one year, two years, three years, and five years — the best active funds have consistently stayed ahead of the benchmark.
This suggests that skilled management can add value not only during long-term market growth but also during shorter market cycles.
Final Thoughts
Passive investing offers simplicity and lower costs. It allows investors to participate in market returns efficiently.
Active investing, on the other hand, aims to go a step further by generating alpha through research, judgement, and portfolio management.
The evidence suggests that in many categories, active funds have delivered higher returns even after accounting for management fees.
Ultimately, the choice between active and passive investing should not be driven by slogans or trends. It should be based on understanding how benchmarks work, how categories behave, and how different strategies aim to create value.
For investors who understand these distinctions, the decision becomes clearer — and the structure of their portfolio becomes stronger
If you would like us to write more about how to choose between active and passive funds for your portfolio, feel free to leave your questions in the comments or contact on +91 93270 34882
