Does your fund manager’s bold and active calls matter?

Bipin Ramachandran with inputs from Vidya Bala

The mutual fund world loves its labels. Active. Passive. Smart beta. Multi-factor. But like most neat categories, reality is messier than the marketing brochures suggest.

The blurring lines

Let’s take “passive” funds that aren’t quite passive. For example, passive indices built on smart beta and multi-factor strategies inject doses of active decision-making into what’s supposed to be hands-off investing. Then there are the “active” funds that cling so tightly to their benchmarks they might as well be index huggers in expensive suits.

Sure, SEBI’s market cap rules create guardrails that prevent fund managers from wandering too far from their designated stock universe. But within those boundaries, there’s still room to dance – to shuffle allocations and show some personality in stock selection.

With passive investing gaining market share and fee compression intensifying, some active fund managers have begun emphasizing their active share as a differentiating factor. The underlying assumption is that greater deviation from the index signals superior active management. But here’s the uncomfortable question: Does being different actually matter?

Defining active share (active calls)

Active share measures the proportion of a fund’s portfolio that differs from its benchmark index. It represents the inverse of overlap between the fund and its benchmark. For instance, if a fund has 30% overlap with the index, it has a 70% active share.

The concept is straightforward, but its implications for fund performance require examination.

Putting active calls to test

We looked at five categories – large cap, mid cap, small cap, flexi cap, and focused funds, over a four-year period from July 2021 to June 2025. We correlated their average 1-year rolling returns with their average active share over this period to see if active shares matter to performance.

Only funds with at least a four-year track record during the observation period were included so as to ensure enough rolling return instances for the period selected. Returns of indices, wherever, mentioned, are that of the total returns of the respective index (TRI returns). 

Methodology note: Our active share calculations are based on the inverse of index overlap. For funds using derivatives, the real active share might tell a different story than our straightforward approach captures.

Large Cap funds – meaningful differentiation a myth

Large cap funds face a fundamental constraint. SEBI mandates that 80% of their assets must camp in the top 100 stocks. This regulatory straitjacket naturally pushes them toward index-hugging behaviour, making true differentiation an uphill task.  Therefore, large-cap funds by mandate tend to have a high index overlap. 

We analysed large cap funds against the Nifty 100 index.

On an average, large cap funds had an active share of 41.65%, meaning well over half their portfolios mirrored the index. Do remember that even this “active” portion often consisted of the same stocks held in different weights. This differential would count as active share. This active share helped outperform the index during the observation period, with average 1-year rolling returns of 16.58% versus 15.05% for the index. But here’s where it gets interesting. 

The range of active shares was substantial—from Canara Robeco’s conservative 32.85% to DSP Large Cap’s bold 61.13%. Yet this nearly 30-percentage-point spread in “activeness” translated to almost nothing in terms of performance correlation (a weak 0.2).

The real story emerges in the outliers. Edelweiss Large Cap Fund, with a modest active share of just 34.48%, delivered stellar returns of 18.05%, proving that sometimes following the market (intelligently) beats blazing your own trail. Meanwhile, Franklin India Large Cap Fund’s high active share of 50.51% led to disappointment, underperforming the index at 14.53%. For details of all the funds, refer to the spreadsheet:

 Mutual fund active share – PrimeInvestor.xlsx

The large cap verdict

In large caps, the evidence suggests that being different for the sake of being different may be a fool’s errand. The regulatory constraints mean that most “active” choices are marginal tweaks rather than bold bets. Smart execution within a familiar framework seems to matter more than dramatic departures from it. In other words, timely entry and exit strategies in the index stocks as well as a high level of success in the limited active share there, would have made a difference.

For investors, this means focusing on a fund manager’s track record of making quality marginal decisions rather than getting seduced by high active share numbers that promise differentiation. 

Midcap funds – more chaos with freedom

If large caps are constrained by regulatory handcuffs, midcaps should be the promised land of active management. With only 65% of assets required to stay within the 151st-250th largest stocks, fund managers have genuine room to showcase their stock-picking prowess. The question is: do they use this freedom wisely?

Midcap funds were analysed against the Nifty Midcap 150 index. Midcap funds certainly embraced their liberty, averaging an active share of 69.52%, significantly higher than their large cap cousins. Yet this expanded canvas for creativity delivered a collective disappointment: average returns of 24.5% that actually trailed the Nifty Midcap 150’s 25.75%.

Active share varied from 57.62% for Nippon India Growth Mid Cap Fund to 86.30% for Quant Midcap Fund. The disconnect between active share and performance was more evident in this category than even the large cap, with a weak correlation of 0.15 between the two variables.

The scatter plot below tells a story of chaos. While there’s a barely perceptible upward trend line, a cloud of funds are scattered across the performance spectrum with little regard for their active share positioning. Nippon India Growth Midcap, the category’s most index-hugging fund, delivered stellar returns of 28.15% – beating both peers and the benchmark. Meanwhile, Motilal Oswal Midcap proved that high active share can still work, topping the charts with 35.76% returns despite; or perhaps because of its aggressive differentiation strategy. And Quant Midcap Fund is a perfect example of how in spite of being maximally different from the index, other factors in play (the fund house allegedly faced corporate governance issues of insider trading) can pull down performance. 

The Midcap verdict

Here’s the uncomfortable truth: more freedom to be different doesn’t automatically translate to better outcomes. In fact, it might create more opportunities to go wrong. The weak correlation suggests that in midcaps, execution matters far more than the degree of deviation from the benchmark. A focused, disciplined approach – whether with 60% or 85% active share trumps blind differentiation.

Small cap funds – skill versus luck dilemma

Like mid cap funds, small-cap funds must invest at least 65% of assets in the universe that SEBI mandates. But this is a large one consisting of stocks below the top 250 by market cap. This opens up a large universe for small cap funds. As these funds are benchmarked against the small cap 250 indices, we measured their active shares against the Nifty Smallcap 250 index (the companies ranked 251-500 in the Nifty 500 from the Nifty Smallcap 250 index). 

Small cap funds embraced their liberation, posting the highest average active share across the categories we analyzed at 81.65%. Yet this maximum differentiation delivered minimum satisfaction: average returns of 25.04% that actually lagged the Nifty Smallcap 250’s 25.62%.

But here’s the real twist: the correlation between active share and performance wasn’t just weak, it was negative at -0.15. In other words, being more different was slightly associated with worse outcomes, partly because differentiation often means avoiding the index’s more speculative components that can drive short-term outperformance.

The underperformance reveals a deeper irony in small cap investing. While fund managers can invest across the vast universe of sub-250 stocks, the question becomes whether they should. The Smallcap 250 index as well as stocks below this market cap, potentially has companies that present two uncomfortable realities: some suffer from liquidity constraints when bought in institutional quantities, and others raise red flags on fundamental quality or governance standards. For example, Valor Estate (earlier known by name DB Realty and a murky past) is not a company that fund managers would easily pick, even if it were part of the Smallcap 250. 

This creates a Catch-22 for fund managers. During broad market rallies, exactly when small caps tend to shoot up the most – the index gets boosted by stocks that prudent managers rightfully avoid. The result? Choosing quality and liquidity over pure performance often means watching from the sidelines as questionable stocks deliver spectacular returns.

The other bigger challenge is the liquidity issue and deployment of inflows. Faced with liquidity issues in the small-cap universe, fund managers are forced to deploy some part of the active share in larger stocks, to ensure they are able to meet any redemption without impact costs. This is more so when inflows are high. Such a strategy means seemingly having an active share but without the potential to deliver the returns that this category needs to. This is one of the reasons why small-cap fund managers tend to shut fresh inflows when deployment becomes a challenge. 

Active share ranged from 72.6% for Nippon India Small Cap Fund to 90.63% for Tata Small Cap Fund.

Nippon India Small Cap Fund, with the lowest active share in the category, posted a solid average return of 29.38%, over 4 percentage points higher than the category average along with Bandhan Small Cap.  On the other hand, funds such as DSP Small Cap Fund and Kotak Small Cap Fund, with a high active share lagged behind both the category and index averages in performance.

The trend line slopes downward, suggesting that higher active shares might actually hurt performance. But even this negative relationship is weak, creating a scatter that looks like fund managers are throwing darts 😊 

The Small cap verdict

For investors, small cap funds offer a sobering lesson about the dangers of conflating activity with skill. The best managers in this space seem to be those who resist the temptation to be maximally different and instead focus on being selectively smart.

Flexi Cap Funds

Flexicap funds have a lot of freedom in stock selection too, with just the caveat that they must invest at least 65% of assets in equity instruments. We analysed these funds against the broader Nifty 500 index.

Despite having the widest investment universe, flexi cap funds showed surprising restraint with an average active share of 63.83%; lower than both mid and small cap categories. This suggests most managers gravitate toward the safety of large cap heavyweights that dominate the Nifty 500, rather than exploring the full opportunity set.

The category displayed the highest variance in approaches, with active shares ranging from Canara Robeco’s conservative 48.56% to Quant’s aggressive 80.02%; a 30+ percentage point spread that reflects vastly different philosophies within the same mandate.

As a category, flexi cap funds delivered on their active share promise, outperforming the Nifty 500 with average returns of 18.69% versus the index’s 17.55%. Interestingly, this category showed the strongest correlation between active share and performance at 0.26 – modest but the highest across all categories analysed.

The scatter plot reveals this relationship more clearly than other categories. While the trend line slopes gently upward and exceptions abound (JM Flexi Cap sits high on the middle, while UTI Flexi Cap languishes at the bottom right), there’s at least some visual coherence to the “more active, decent returns” thesis here.

The Flexicap verdict

Flexi cap funds may represent the optimal balance: enough freedom to make meaningful allocation decisions across market caps, but not so much rope that managers hang themselves with obscure stock picks. The ability to dynamically shift between large, mid, and small caps based on market conditions appears to reward active decision-making in this category more than categories with constraints laid down.

For investors, flexi cap funds offer the best evidence that active share can matter. But even here, the correlation remains weak enough that fund selection should focus on manager skill rather than simply deviation metrics.

Focused Funds – limits of forced activity

Focused funds are similar to flexi cap funds in terms of where they can invest. That is, at least 65% of assets must be in equity instruments. However, they have one additional restriction, they can hold a maximum of 30 stocks. This combination should theoretically force meaningful differentiation from broad market indices, making them an ideal test case for whether concentration drives active share effectiveness. We analysed focused funds also against the broader Nifty 500 index.

The average active share for focused funds was 69.77%. While this is on the higher side among the categories analysed, it is not much greater than flexi cap funds, which had an average active share of 63.83%. This suggests that even when forced to hold just 30 stocks, managers gravitate toward the largest-weighted components of the Nifty 500, limiting true differentiation.

The range was notable, spanning from Aditya Birla Sun Life’s 58.94% to SBI Focused Fund’s 80.49%. The most conservative focused fund had higher active share than the most conservative flexi cap fund.

On performance, focused funds delivered average 1-year rolling returns of 18.37%, similar to Flexicap funds and higher than the index return of 17.55%.

However, the relationship between active share and performance was essentially non-existent, with a correlation of -0.06; the weakest among all categories analysed.

The scatter plot confirms this lack of pattern. The trend line is virtually flat, with successful funds like ICICI Prudential and Invesco India clustered in different active share zones, while disappointing performers like Axis and SBI are scattered across the spectrum.

The Focused fund verdict

Focused funds demonstrate that structural constraints alone don’t guarantee meaningful active share benefits. While the 30-stock limit ensures deviation from broad indices, it doesn’t ensure that deviation is purposeful. The near-zero correlation suggests that in this category, stock selection quality matters far more than the degree of index deviation.

For investors, focused funds offer a lesson about the difference between concentration and conviction. 

Conclusion

The logic behind high active share funds is that they should generate higher returns. But if an active portfolio largely mirrors the index, why not choose a cheaper passive fund instead? High active share should signal that managers are making meaningful calls rather than hugging benchmarks.

What the Data Shows: Our analysis across five categories over four years reveals weak to non-existent relationships between active share and performance. Correlations ranged from a modest 0.26 (flexi cap) to negative -0.15 (small cap). Even the strongest relationship was barely meaningful statistically.

Each category told a similar story:

• Large cap funds showed that regulatory constraints limit meaningful differentiation. 
• Mid cap funds demonstrated that more freedom doesn’t guarantee better outcomes.
• Small cap funds revealed how prudent managers often underperform by avoiding questionable stocks that drive index rallies and are limited by liquidity issues.
• Flexi cap funds provided the best case for active share mattering, but correlations remained weak. 
• Focused funds proved that forced concentration doesn’t ensure skilful stock selection.

The Bottom Line: Active share alone cannot work as a fund selection criterion. Some top performers like Nippon India Large achieved strong returns with conservative active shares, while many high active share funds disappointed. The data suggests that execution quality matters far more than deviation from benchmarks.

Investors should stick to traditional evaluation metrics: risk-adjusted returns, manager track records, and investment processes. Poor performers don’t belong in portfolios regardless of their active share, and strong performers don’t need high differentiation to justify inclusion.

This is where PrimeInvestor tries to offer a blend of active and passive funds, depending on performance and portfolio quality and potential, rather than mere overlap or the lack of it. Check Prime Funds for such active/passive choices.

You can also read more on active funds vs passive funds here: Making the Choice: Active or Index Funds for Your Portfolio? – PrimeInvestor