Go active or be passive? Let the numbers decide

Summary: Should you fully go active or passive? Or have a balance of both? There’s no clear answer. Here, we look at which mutual fund categories favour active management versus those where passive investing works better.

What should be the ideal ratio between active and passive funds? Within equity, what should be the ratio between large-cap and mid-cap funds? Does a flexi-cap fund alone suffice? Is there a flexi-cap index fund? – Jayasheela

The ‘active vs passive’ debate is akin to the ‘chicken or the egg’ dilemma. There’s no clear answer. 

However, unlike the latter, the confusion between active and passive has less to do with philosophy and more to do with economics. While both approaches have their strengths and drawbacks, each category fares differently across mutual fund categories.

But what is more important is whether the fee paid for active management can meaningfully translate to outperformance, after costs are deducted.

Why? Because gross outperformance alone can be misleading. A fund that beats its benchmark by 1 per cent may look successful on paper. But if it charges an expense ratio of 0.88 per cent while an index fund charges 0.23 per cent and delivers nearly similar returns, the net advantage shrinks dramatically. Over time, that cost gap compounds quietly and persistently.

So, the right question is not whether active can outperform. It is whether it can outperform enough to justify its fee.

Where does active management hold merit?

To find out, we decided to check how often active funds across each category (large, mid and small) outperformed their respective indices.

Based on the data above, here’s what we can conclude.

Large-cap funds

• Actively-managed large-cap funds have outstripped their benchmark (Nifty 100 TRI) in around 61 per cent of five-year rolling return periods.
• While the number seems appealing, these wins only come in the 0-2 percentage point band. This proves that while active large-cap fund managers beat the index, the margin is quite narrow, which doesn’t clearly justify the underlying fee and costs.
• Reason? Large-cap companies are among the most widely researched and tracked companies, indicating that information is quickly priced in. In such an environment, paying significantly more for marginal excess return is difficult to justify. This is where low-cost passive investing makes structural sense.

Suggested read: Are active large-cap funds back in the game?

Mid-cap funds

• When it comes to active mid-cap funds, the margin of outperformance versus the benchmark (Nifty Midcap 150 TRI) is much lower, at just 27.1 per cent for the 0-2 percentage band.
• Yet, a closer look shows that the outperformance is dispersed, but unpredictable. This suggests that while opportunities may exist, they are harder to consistently capture at the category level.
• For investors, this raises an important question: are you confident in your ability to identify the relatively few managers who can deliver persistent alpha? If not, the case for blending passive exposure even in mid caps becomes stronger.

Small-cap funds

• Active management seems to perform best in the small-cap segment, since active funds in the category beat the parent index (Nifty Smallcap 250 TRI) in nearly 98 per cent of five-year rolling return periods. 
• What’s more, the distribution of outperformance is meaningfully wider. A substantial portion of results falls in the 2 to 6 per cent range, with a notable share exceeding 6 per cent. Even after accounting for higher expense ratios, this magnitude of excess return leaves room for genuine net alpha.
• Reason? Small-cap companies are less efficiently priced, more volatile and more prone to mispricing. That environment allows skilled managers to differentiate themselves and generate substantial alpha. 

Does this mean active management is futile?

Not really. Active fund management still holds relevance, provided market inefficiency is high, allowing fund managers to grab opportunities that can compound meaningfully.

Suggested read: Active vs passive investing: Which is right for you?

The right way to think about active versus passive is therefore not as a fixed ratio but as a layered approach. Use passive exposure where costs dominate and outperformance margins are narrow, such as large-cap funds. Consider active strategies with evidence of meaningful net alpha, such as in small caps. Approach mid caps with caution and realism, recognising that consistent outperformance is harder than theory suggests.

The ideal allocation between active and passive cannot be determined in isolation. It depends on risk appetite and time horizon. Investors with shorter horizons or lower tolerance for volatility may prefer the predictability and cost efficiency of passive exposure, while those with longer horizons and a high risk appetite may allocate more to active strategies in segments where skill has historically mattered.

Also read: Fund Radar: Active/passive: What's better?

This article was originally published on February 21, 2026.