Actively managed fund
A scheme whose fund manager chooses the portfolio within the broad limits of the investment objective, aiming to beat its benchmark — at a higher running cost than a passive fund.
In plain language
In an actively managed fund, a person makes the calls. The workbook: the fund manager has the flexibility to choose the investment portfolio, within the broad parameters of the investment objective of the scheme.
Two consequences follow in the same paragraph. The expenses for running the fund turn out to be higher, because the manager's role is larger. And investors expect actively managed funds to perform better than the market.
That expectation is the whole bargain: the investor pays more, for the chance of more.
How it works
How an active manager tries to win. Chapter 7 explains the mechanism. Company-specific (unsystematic) risk can be diversified away; market-wide (systematic) risk cannot, and finance theory says investors are rewarded only for systematic risk. So to outperform the benchmark, the manager has no choice but to take certain unsystematic risks by taking a view on individual securities. Some managers also shift between equities and cash depending on their outlook — but SEBI regulations limit the extent of cash allocation.
What good looks like. An actively managed fund should ideally perform well in rising markets and decline less than its benchmark in falling markets.
How it is judged.
| Measure | What the workbook says |
|---|---|
| Information ratio | (Portfolio return − Benchmark return) ÷ Standard deviation of excess return; the only risk-adjusted measure that is mandatory to disclose, daily, against the tier-I benchmark |
| Tracking error | Now used to measure how consistently a fund out-performs its benchmark — a high excess return is not enough, it must be consistent |
| Sharpe and Treynor ratios | Risk premium per unit of standard deviation or beta |
Benchmark choice. For an index fund the benchmark is obvious. For other schemes it is subjective, decided by the AMC in consultation with the trustees, disclosed in the SID and aligned with the objective, asset allocation and strategy.
The formula
Information Ratio = (Portfolio return − Benchmark return)
÷ Standard deviation of excess return
A worked example
Farhan holds Rs 5,00,000 in an actively managed large-cap fund. All returns are illustrative.
| Year | Benchmark | Fund | Fund on Rs 5 lakh |
|---|---|---|---|
| Rising market | +12% | +14% | +Rs 70,000 (index would give Rs 60,000) |
| Falling market | −10% | −7% | −Rs 35,000 (index would lose Rs 50,000) |
That is the pattern the workbook calls ideal: ahead when markets rise, declining less when they fall.
Information ratio. Suppose over three years the fund averaged 2 percentage points a year above its tier-I benchmark, with a standard deviation of excess return of 2.5:
IR = 2 ÷ 2.5 = 0.8
A second active fund also beat the benchmark by 2 points on average, but with a standard deviation of excess return of 5, giving 0.4. Same average outperformance — the first manager delivered it far more consistently.
Farhan's scheme also charges more than an index fund. If its extra expense were 1 percent a year and it only matched the benchmark before costs, he would lag the index by about Rs 5,000 a year on his holding.
Why NISM asks about it
Chapter 2.2.2 (By the management of the portfolio) defines actively managed and passive funds side by side — expect a comparison question on who decides the portfolio, relative cost, and whether the fund aims to beat the market. Chapter 7.3 explains why active managers must take unsystematic risk, and 7.4 supplies the information ratio and the "decline less in falling markets" standard.
Common exam traps
- Active funds cost more because the fund manager's role is larger — not because of any special regulatory charge.
- To outperform, an active manager must take unsystematic risk; systematic risk cannot be diversified away.
- The information ratio is the only mandatory risk-adjusted disclosure, made daily against the tier-I benchmark.
- Tracking error has changed meaning — once a check on index funds only, it is now used to judge the consistency of an active fund's outperformance.
- The manager's freedom is bounded by the investment objective and SEBI's category rules, including limits on holding cash.
Where this is taught
- Series V-D · Chapter 2: Concept & Role of a Mutual Fundintroduced here
- Series V-B · Chapter 2: Concept and Role of a mutual fundintroduced here
Related terms
- Systematic riskThe part of an investment's risk that comes from economy-wide forces moving every asset at once — it cannot be diversified away, and it is the only risk the market pays you to carry.
- Unsystematic riskThe part of an investment's risk that belongs to one company or one issuer — a strike, a fraud, a downgrade — and which diversification can remove, unlike market-wide systematic risk.
- Total Expense RatioThe all-in annual cost of a mutual fund scheme as a percentage of daily net assets — the base expense ratio plus brokerage, transaction cost and statutory levies — charged to the scheme, not billed to the investor.
- BenchmarkThe independently published index a scheme's performance is measured against, chosen to match its investment objective, asset allocation and strategy, and disclosed in the Scheme Information Document.
- Information RatioActive return over the benchmark divided by tracking error — how much outperformance a manager delivers for each unit of risk taken by deviating from the index.
- Passive fundA scheme that invests according to a specified index, holding its shares in the index's own weights, so it mirrors the index instead of trying to beat the market — and costs little to run.
- Tracking errorThe gap between the return of a passive fund and the return of the index it is trying to replicate — the measure of how faithfully an index fund or ETF does its one job.
- Flexi Cap FundAn open-ended equity scheme that must keep at least 65 percent in equity and may move that money freely across large, mid and small cap stocks, with no fixed split.
- Smart Beta FundAn extension of index funds and ETFs that changes how the index is weighted — equal weights or other parameters instead of market capitalisation — to improve returns, diversify more and reduce risk.
- Diversified equity fundAn equity scheme that invests across a wide spectrum of companies drawn from several industries, so that no single company and no single industry can sink the portfolio.