Passive Funds - Meaning, How It Works and Types (2024)

Passive mutual funds, as a long-term investment strategy, prioritise maximising the returns by minimising frequent buying and selling. Unlike active investing, which aims to outperform the market, passive investing involves holding a diversified mix of assets that mirrors specific market segments. The most common approach is investing in index funds, which provide a valuable addition to your investment portfolio. This article will explain about passive funds and how they serve as a valuable addition to your investment portfolio.

What are passive funds?

Passive mutual funds consistently mirror the performance of a market index to maximise returns. The portfolio of a passive fund precisely replicates a designated market index, such as Nifty or Sensex, with the composition and proportion of investments matching the tracked index.

In contrast to active funds, passive funds operate without the need for the fund manager to actively select individual stocks. This simplicity makes passive funds more accessible and easier to monitor compared to their active counterparts. Investors opt for passive funds to align their returns with overall market performance. The cost-effectiveness of these funds is notable as they do not incur expenses associated with stock selection, research, or frequent trading of securities. This cost efficiency contributes to the appeal of passive funds as an uncomplicated and economical investment option.

How does passive funds work?

Passive investing revolves around choosing a market index and forming its replica by investing in the same stocks in a similar proportion as done by the index. After that, the fund starts tracking the index closely and making changes to the portfolio as per the underlying index to make the fund closely identical to the index. When it comes to passive funds, there is no process related to selecting stocks, as the stocks of these funds are like that of their underlying indices. Therefore, fund managers play a limited and passive role, which is the ultimate meaning of passive funds.

Types of passive funds

There are several types of passive mutual funds for investors to build wealth over time. Here are some of the most popular ones:

1. Index funds: Index funds are mutual funds or exchange-traded funds (ETFs) that track a specific market index, such as Sensex or Nifty. They are designed to replicate the performance of the index they track and offer investors broad exposure to a particular segment of the financial market.
2. Exchange Traded Funds (ETFs): ETFs are a type of passive fund that tracks the performance of an underlying index. An ETF is a portfolio that closely resembles an index. ETFs don’t try to outperform their benchmark indexes. Furthermore, ETFs trade on the stock exchange, and thus one can buy and sell ETFs on the exchange. As a result, the ETF prices fluctuate throughout the day.
   
3. Fund of Funds (FOFs): FOFs are mutual funds that invest in other mutual funds. They are designed to provide investors with a diversified portfolio of funds. FOFs can be actively or passively managed.
   
4. Smart beta: Smart beta funds are similar to ETFs in many ways. They combine the benefits of passive funds with the selection of active investments based on certain criteria. This allows the fund to generate higher returns using a cost-effective model.
   

On one hand, smart beta funds follow the underlying index when it comes to performance. On the other hand, they make changes to their portfolios based on market movements. Like ETFs, smart beta funds lack fund manager bias.

How to strategise your approach to investing in passive funds

Here are the key points to consider when strategising forpassively managed funds:

1. Identify objectives:

• Determine your financial goals (e.g., retirement, education funding, wealth accumulation).
• Clear objectives guide your choice of passive funds.

2. Diversify your portfolio:

• Spread riskby allocating investments across asset classes, sectors, and regions.
• ConsiderETFs,Index Funds,Smart Beta Funds, andFunds of Funds.

3. Assess risk tolerance:

• Understand your comfort level with volatility.
• Choose funds aligned with your risk appetite.

4. Long-term focus:

• Patienceis key for passive investing.
• Short-term market fluctuations matter less over time.

5. Monitor and rebalance:

• Regularly review your portfolio.
• Adjust asset allocation as needed to maintain diversification and risk exposure.

Pros and cons of passive investing

Like any investment strategy, investing in passive mutual funds has its benefits and disadvantages. Here is a quick look at both:

How to invest in passive funds with Bajaj Finserv?

Investing in passive funds is relatively easy on the Bajaj Finserv platform. Just select the mutual fund scheme you want to invest in and follow these steps:

• Step 1: Click on INVEST NOW. You will be redirected to the mutual funds listing page.
• Step 2: Filter by scheme type, risk appetite, returns, etc. or choose from the top performing funds list.
• Step 3: All the mutual funds of the particular category will be listed, along with the minimum investment amount, annualised return, and rating.
• Step 4: Get started by entering your mobile number and sign in using the OTP.
• Step 5: Verify your details using your PAN, date of birth.
  If your KYC is not complete, then you will have to upload your address proof and record a video.
• Step 6: Enter your bank account details.
• Step 7: Upload your signature and provide some additional details to continue.
• Step 8: Choose and select the mutual fund that you want to invest in.
• Step 9: Choose whether you want to invest as SIP or lumpsum and enter the investment amount. Click on ‘Invest Now’
• Step 10: Select your payment mode i.e., net banking, UPI, NEFT/ RTGS
• Step 11: Once your payment is done, the investment will be complete

Your investment will start reflecting in your portfolio within 2-3 working days.

Conclusion

Passive investing, a long-term strategy, aims to maximise returns by minimising frequent buying and selling. Unlike active investing, which seeks to outperform the market, passive investing involves holding a diversified mix of assets that mirrors specific market segments.

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