Making the Choice: Active or Index Funds for Your Portfolio?

Whenever there’s a buying opportunity in the markets, a key choice that fund investors need to make is whether they must buy active funds or passive funds. This time is no different. 

The active versus passive debate began in the West, with John Bogle of Vanguard who championed passive investing in the 1970s. Today, a majority of retail investors in developed markets favour passive investing. How do active funds perform versus passive ones in India? This depends on the fund category you’re looking at. 

We decided to analyse rolling returns data to help you with this call in each equity category. 

What we did

This analysis evaluates how active fund categories perform against their benchmarks. It’s not aimed at identifying which funds to invest in. For that, head to Prime Funds and Prime MF Ratings.

Short bursts of strong index performance can skew comparisons, even when using rolling returns. To address this, we analyzed performance over extended timeframes.

We selected April 1, 2018 (when SEBI’s fund categorization rules took effect) through March 31, 2025, giving us a comprehensive 7-year window.

While 5-year rolling returns would have been ideal, this would have yielded only two years of post-2018 categorization results. Instead, we used 3-year rolling returns—a calculation that measures performance across several 36-month periods. This approach provided four years of valuable comparative data, with the first period spanning April 1, 2018, to April 1, 2021, and the final period covering March 31, 2022 to March 31, 2025.

Important: Our analysis includes only those funds in each category that have 3-year return data available within our 7-year window study period. Due to varying launch dates and track records, some funds have fewer 3-year return instances while others (with longer histories) have more data points within the 7-year window. This variation in data density is inevitable when data is averaged.

Categories analysed

We compared active funds in the following categories against their respective Nifty indices:

Category

• Flexi cap
• Focused
• ELSS
• Large cap
• Large & Mid cap
• Mid cap
• Small cap

We excluded the Multicap category. Though it can be compared against the Nifty 500 Multicap 50:25:25 Index, most funds here were either launched or reclassified as Multicap only after SEBI’s 2021 rule changes.

For all categories, we analysed only direct plans.

Flexicap funds vs index

3-year rolling average returns of Flexicap funds with 7-year track record vs index returns

Flexicap funds must invest at least 65% of assets in equities, with no restriction on market cap allocation. We benchmarked this category against the Nifty 500 TRI.

Results

• Flexicap average 3-year return: 18.52%
• Nifty 500 TRI 3-year return: 18.63%
• Category outperformance over index (3-year returns): 49.03% of the time
• No. of funds that outperformed: Among 19 funds with a 7-year track record, 9 funds delivered average 3-year returns better than the index. 10 funds underperformed

Flexicap funds have closely tracked the index. Their average return (18.52%) is only slightly below the index (18.63%). They beat the index nearly half the time (49.03%), and roughly half the funds with long track records managed to outperform. But do remember that there are funds outperforming the index well as seen in the table above.

Focused Funds vs index

3-year rolling average returns of Focused funds with 7-year track record vs index returns

The Focused fund category, like Flexicap, must invest at least 65% of its assets in equities. It has no market cap restrictions, but must limit its portfolio to a maximum of 30 stocks. We compared these funds against the Nifty 500 TRI.

Results

• Focused category 3-year average return: 18.7%
• Nifty 500 TRI 3-year return: 18.63%
• Outperformance over index (3-year returns): 59.31% of the time
• No. of funds that outperformed: Among 16 funds with a 7-year track record:7 funds beat the index on average 3-year returns. 9 funds underperformed

Focused funds have narrowly outperformed the index, with average returns of 18.7% compared to 18.63%. They beat the index about 60% of the time. However, only 7 out of 16 funds with a long-term track record managed to outperform.

Equity Linked Saving Schemes (ELSS) funds vs index

3-year rolling average returns of ELSS funds with 7-year track record vs index returns

The ELSS category also has no market cap restrictions but is required to invest at least 80% of assets in equities. We compared it against the Nifty 500 TRI as well.

Results

• ELSS category 3-year average return: 19.3%
• Nifty 500 TRI 3-year return: 18.63%
• Outperformance over index  (3-year returns): 86.06%
• No. of funds that outperformed: Among 31 funds with a 7-year track record, 16 funds beat the index on average 3-year returns. 15 funds underperformed.

ELSS funds showed the most striking results, outperforming the index across all metrics. However, this category has an outlier — Quant ELSS, whose strong returns were far ahead of the rest of the funds. That fund’s performance started declining in mid-2024, and this shift has not yet fully reflected in the 3-year rolling returns. Including Quant ELSS, the category average return is 19.3%, compared to the index return of 18.63%. Excluding Quant ELSS, it falls to 18.85% — still better than the Flexicap and Focused category averages. The category has beaten the index 86% of the time when Quant ELSS is included; without it, this drops to 57% — still good and close to the Focused funds category. Out of the 31 ELSS funds with a long-term track record, 16 managed to outperform the index.

Large Cap Funds vs index

3-year rolling average returns of large cap funds with 7-year track record vs index returns

The Large Cap category must invest at least 80% of assets in large-cap stocks. We compared this category against the Nifty 100 TRI index.

Results

• Large-cap category 3-year average return: 16.92%
• Nifty 100 TRI 3-year return: 16.74%
• Outperformance over index (3-year returns): 54.83%
• No. of funds that outperformed: Among 24 funds with a 7-year track record:14 funds had average 3-year returns higher than the index. 10 funds underperformed. 

Despite receiving the most criticism the large cap category has held up reasonably well against index funds in recent years. The average returns have been slightly above the index. The category beat the index more than half the time, and nearly 6 out of 10 funds with long-term track records managed to outperform. Notably, even the underperforming funds did not lag the index by a wide margin, while the outperformers posted meaningful excess returns. But this scenario was very different a few years ago when large caps underperformed indices significantly. So the lesson is that at different periods, different strategies (active, passive) can work. 

Mid Cap Funds vs index

3-year rolling average returns of mid cap funds with 7-year track record vs index returns

The Mid Cap category must invest at least 65% of assets in mid-cap stocks. We compared it against the Nifty Midcap 150 TRI.

Results

• Midcap category 3-year average return: 24.33%
• Nifty Midcap 150 TRI 3-year return: 25.27%
• Outperformance over index (3-year returns): 29.91%
• Number of funds that outperformed: Among 22 funds with a 7-year track record, 9 funds beat the index on average 3-year returns and 13 funds underperformed.

Mid cap funds have struggled to outperform the index. The average returns trailed the index by nearly 1 percentage point. The category beat the index in less than 30% of the observations. Among funds with a long-term track record, fewer than 4 in 10 managed to beat the index.

Small Cap Funds vs index

3-year rolling average returns of small cap funds with 7-year track record vs index returns

The Small Cap category must invest at least 65% of assets in small-cap stocks. We compared it against the Nifty Smallcap 250 TRI.

Results

• Small-cap category 3-year average return: 29.01%
• Nifty Smallcap 250 TRI 3-year return: 25.78%
• Outperformance over index (3-year returns): 93.91%
• Number of funds that outperformed: Among 14 funds with a 7-year track record, 12 funds beat the index on average 3-year returns while 2 funds underperformed.

The small cap space continues to be fertile ground for active fund managers. In all the metrics we checked, active funds outperformed the index by a significant margin. Possible reasons include: A broader universe of small-cap stocks. All stocks below the top 250 qualify as small-caps (compared to the limited basket of 150 or 100 for mid and large caps). Fund managers using the remaining 35% allocation tactically — investing in microcaps to boost returns or shifting to large caps/cash to contain downside — and more importantly, getting it right!

However, a few caveats:

• The number of funds with long-term track records is relatively low.
• Assets under management swelled significantly post-COVID, and it remains to be seen whether this affects fund manager’s ability to generate alpha, especially in bull markets.
  

In this category, Quant Small Cap has been a major outlier with significantly higher returns. However, even excluding it, the category comfortably beats the index. The average return of the category is 29.01% versus 25.78% for the index. Excluding Quant Small Cap, the category average stands at 28.03%. With Quant Small Cap, the category has beaten the index 93.9% of the time; without it, this figure only drops to 88.4%; still outstanding. The most impressive results came from the funds that have existed for the full 7-year period since 2018 — 12 out of the 14 managed to beat the index. One of the two that trailed the index lagged by only a small margin.

Large and Mid-cap Funds vs index

3-year rolling average returns of Large and Mid Cap funds with 7-year track record vs index returns

The Large and Mid-cap category must invest at least 35% each in large-cap and mid-cap stocks. We compared this category against the Nifty LargeMidcap 250 TRI index.

Results

• Large Midcap category 3-year average return: 20.77%
• Nifty LargeMidcap 250 TRI 3-year return: 21.03%
• Outperformance over index (3-year returns): 43.23%
• Among 20 funds with a 7-year track record:
  • 9 funds had average 3-year returns higher than the index
  • 11 funds underperformed

The Large and Midcap category has also struggled to beat its index. The average returns have been slightly below the benchmark, and the category outperformed the index in only 43% of rolling return periods. Among long-term funds, fewer than 4 in 10 managed to beat the index.

What to do

The debate between active and passive funds isn’t about which is universally superior—it’s about which approach best serves your specific needs.

While a purely passive portfolio is perfectly valid, expecting it to consistently outperform active management in the Indian market may lead to disappointment. Our research at PrimeInvestor consistently shows that a thoughtful blend of both approaches typically yields optimal results. That is how we choose our Prime Funds.

We evaluate each fund category on its individual merits, recommending passive options when active funds underperform and shifting to active management when opportunities arise. For example, our recent large-cap recommendation is an active fund, while in another category, we’ve taken the index fund approach (see our recent analysis: Prime Fund Recommendation: An equity index fund to ‘buy the market’).

As a PrimeInvestor subscriber, you benefit from our continuous analysis, significantly reducing the effort required to maintain this balanced investment approach.