Active fund management works well for debt funds

Active fund management and passive fund management are broadly the two opposite ends of the investment spectrum. The active fund management school of thought is built on principle that, due to inherent market inefficiencies and various risks, there are numerous opportunities available for an expert to add substantial value to overall returns. 

On the other side, passive investment strategies are designed to simply mirror the composition and performance of a specific benchmark. Currently, the biggest attraction for passive fund management style is relatively lower cost charged to investors. However, time and again, the dynamism of active strategies has proved to be better in capturing value and managing risk thus cancelling the rigidity and inflexibility that are traits of passive fund management, especially in an ever changing market. 

Benefits of active fund management

Active fund management offers many benefits for investors that go well beyond just security selection and beating an index. Fund managers use fundamental research, quantitative analysis, and expert trading to outperform their benchmarks. They also try to understand the investment objectives and risk tolerance of investors and construct specific portfolios that aim to optimise returns as per the stated investment objectives of each portfolio or investment vehicle. Managing risks holistically is as much an objective as return generation. It is pre-dominantly active fund management that is on top of the constantly evolving scenario and generates favourable risk adjusted returns. 

Coming to the Indian market, most of the times, during rising markets, active funds have beaten the index by a wide margin. When markets have fallen, their performance has been mixed. On an average, extra returns provided by actively managed mutual funds have been much higher than the extra cost charged for delivering the return. 

Active funds work better for debt funds

Active fund management holds an even greater appeal for debt market investments, given their complex semi-opaque nature, heterogeneous nature of underlying products, characterised by the bouts of illiquidity and ever changing credit environment. Debt fund managers typically look to add alpha, mostly through duration and liquidity management and credit selection. Active debt funds are able to generate excess returns, even in an environment of rising interest rates by reducing the duration of bonds according to expectations of the future direction of interest rates. They benefit through credit selection where the fund manager analyses the credit quality of an issue for any likely deviations in creditworthiness, and accordingly invests where the credit profile is likely to improve in future or divests if the analysis infers that the credit profile is likely to worsen going ahead. Also during adverse market conditions, market corrections or high volatility, active fund management enables fund managers to preserve capital or contain declines through churning or by moving in to cash. 

Active fund management, as compared to passive fund management, will continue to remain a predominant style of investment because of their ability to add immense value through constant research and monitoring, idea generation, security selection and trade execution. Overall a rupee invested through active fund management versus a rupee invested through passive fund management will continue to be a compelling value proposition because it works harder and offers more protection.

The writer is, head – fixed income, Indiabulls Asset Management