# Active vs passive mutual funds: what is the difference?

Source: https://koshex.com/blog/active-vs-passive-mutual-funds-know-the-difference · Published 4 May 2025 · 9 min read

In an active fund, a manager chooses what to buy within SEBI's rules for the fund's category and tries to do better than an index. In a passive fund, the index decides, so the fund holds the same securities in the same proportions. Both are mutual funds. They differ in who decides, fee ceilings and tracking.

## Key takeaways

- An index fund is a mutual fund. The real choice is active or passive, meaning a manager decides what the fund holds or an index does.
- SEBI's base fee ceiling is 0.90% for an index fund and 2.10% on the first ₹500 crore for an active equity fund. These are ceilings, not what every fund charges.
- Passive funds are not safer by default. Risk comes from what a fund holds, so an index fund falls when its index falls.
- To judge an active fund, compare its returns after costs with an index fund on a comparable index over the same periods.

In an active fund, a manager chooses what to buy within SEBI's rules for the fund's category and tries to do better than an index. In a passive fund, the index decides what the fund holds. Both are mutual funds. The choice is not "mutual fund or index fund". It is who runs the money: a person or a rule.

A mutual fund, to start with, is a pool of money from many people, invested by a professional manager under SEBI rules. An index is a list of companies picked by fixed rules, such as the 50 in the NIFTY 50. Its combined value is tracked every day.

## What is the difference between active and passive funds?

The difference is who decides what the fund owns: a fund manager in an active fund, an index in a passive one. An active fund's manager picks the holdings. SEBI sets a floor for the fund's category, and the manager chooses within it. A large cap fund, for example, must keep at least 80% of its money in the 100 biggest listed companies. What it buys within that is the manager's call.

A passive fund has no such room. Its job is to copy an index, and SEBI's rules tie it to that index closely. The fund must keep at least 95% of its money in the securities, meaning the shares or bonds, of the index it follows. After the index changes, the fund must bring its holdings back in line with the index within 7 calendar days.

An active fund is judged against a benchmark, which is an index its returns are compared with. A passive fund is judged on how closely it follows its own index.

|  | Active fund | Passive fund |
| --- | --- | --- |
| Who decides the holdings | A fund manager | The index |
| SEBI rule | A category floor, such as 80% in the top 100 companies for large cap | At least 95% in the securities of the index; rebalance within 7 calendar days of an index change |
| Aim | Do better than a benchmark | Match the index, less fees |
| SEBI's ceiling on the base fee (equity) | 2.10% on the first ₹500 crore of assets, lower in slabs after that | 0.90% |
| How it is measured | Returns against the benchmark | Tracking error and tracking difference |
| Risk label | Follows what the fund holds | Follows what the index holds |

Tax depends on what a fund holds, not on whether it is active or passive.

## Is an index fund a mutual fund?

Yes. An index fund is a mutual fund scheme in SEBI's "Index Funds/ETFs" category, run by a SEBI-registered fund house like any other scheme.

SEBI's regulations describe an index fund as one that invests in securities in the same proportion as an index. So the question people type, "index fund or mutual fund, which is better?", mixes two different things. The real question is active or passive.

An ETF, short for exchange traded fund, follows the same idea but its units are listed and traded on a stock exchange. If you are weighing an ETF against an index fund, [ETF or index fund: what is the difference?](https://koshex.com/blog/etf-vs-index-fund) covers that choice.

## What kinds of passive fund are there?

Index funds and ETFs are the main kinds, and SEBI also allows passive ELSS, target maturity, hybrid passive and passive fund of funds versions.

- **Index funds and ETFs.** A fund house may run several, one for each distinct index. ETFs can hold shares, bonds, gold, silver or a mix. Gold and silver ETFs track the domestic price of the metal. See [exchange traded funds](https://koshex.com/blog/exchange-traded-funds).
- **Passive ELSS.** A fund house can launch either an active ELSS or a passive one. The passive version is an index fund built on an index of the top 250 companies by market capitalisation. That is a company's size: its share price times its number of shares. More on [ELSS funds](https://koshex.com/mutual-funds/categories/elss-funds).
- **Target maturity funds.** These are debt ETFs or index funds that track a target-maturity index. No security in the portfolio may mature after the target date. See [target maturity funds](https://koshex.com/mutual-funds/categories/target-maturity-funds).
- **Hybrid passive funds.** SEBI lets fund houses launch a passive fund that copies one composite index. That index mixes equity (shares) and debt (bonds and similar loans). There are three categories: balanced, equity oriented and debt oriented.
- **Funds of funds that hold one index fund or ETF.** A fund of funds invests in other funds. One that simply holds a single index fund or ETF is passive. One that invests in several funds is treated by SEBI's scheme document instructions as having an active strategy. [ETF or fund of funds](https://koshex.com/blog/etf-vs-fof) explains the difference.

Indian ETFs always track an index. SEBI's rules make no provision for an actively managed ETF.

Funds built on factor indices, which pick companies by a rule, are also passive. [Factor investing](https://koshex.com/blog/factor-investing) covers them.

## What does each cost?

SEBI lets an active equity fund charge a higher yearly fee than an index fund, and that fee comes out of your returns every year.

The fee is the expense ratio: the fund's yearly charge, shown as a percentage of your money and taken out of the fund's value. SEBI sets maximums, and these are ceilings, not what every fund charges. The total expense ratio is the base fee plus brokerage, trade costs and taxes such as GST. [What is an expense ratio](https://koshex.com/blog/what-is-expense-ratio-and-why-is-it-important) goes into the parts.

The base fee ceilings are:

- **Index fund or ETF:** 0.90% of daily net assets, a flat ceiling.
- **Open-ended active equity fund:** 2.10% on the first ₹500 crore of assets, then lower in steps. The balance of a very large fund is capped at 0.95%.

Here is what that looks like in rupees. Say ₹2,00,000 sits in a fund for a year, and each fund charges its ceiling. The index fund would charge ₹1,800. An active equity fund with under ₹500 crore of assets would charge ₹4,200. The gap is ₹2,400 a year, and it comes out of the active fund's value before you see any return.

The ceilings fall in slabs as a fund grows. Each slab's rate applies only to the part of the fund's assets in that slab. So the ceiling for a large fund is a mix of all its slab rates, not its lowest one.

Look at the actual expense ratio of the scheme you are considering.

A passive fund has its own cost: its return is the index's return less fees and a small gap. Tracking error measures how far its daily returns stray from the index over the past year. SEBI says it must not exceed 2% for a non-debt fund. Tracking difference is the gap between the fund's return and the index's return over a period. For equity passive funds, SEBI targets that gap at 0.50 percentage points above the fee actually charged.

## Are passive funds safer than active funds?

No. A fund's risk comes from what it holds, and an index fund on the NIFTY 50 falls when the NIFTY 50 falls.

Two past falls in the NIFTY 50 price index show this. Between 8 January and 27 October 2008 it lost 59.9%, closing at 2,524.20 against 6,287.85. Between 14 January and 23 March 2020 it lost 38.4%, closing at 7,610.25 against 12,362.30. An index fund on that index falls with it.

The riskometer, SEBI's risk label on six levels from Low to Very High, shows the same thing. Every listed large cap fund, and almost every listed index fund, read Very High on 29 September 2026. The label followed the market each fund holds, not whether a manager or an index was in charge.

What passive does take away is one kind of risk: a manager's choices going wrong on their own. What it keeps is market risk, the risk of the whole market falling. The wider picture is in [what are the risks involved in mutual funds](https://koshex.com/blog/what-are-risks-involved-in-mutual-funds).

## What should you compare before paying for active management?

Compare the active fund's returns after its costs with the returns of an index fund on a comparable index, over the same periods.

Active management is a choice to pay for a manager's decisions within the category floor. Whether that has paid off for a particular fund shows up in that comparison. [Five ways to measure mutual fund risk](https://koshex.com/blog/5-ways-to-measure-mutual-fund-risk) shows how to read a fund against its benchmark.

A few things shape the comparison:

- **Whether a low-cost index version of the same market exists.** If it does, it gives you a yardstick.
- **How much tracking matters to you.** An index fund stays close to its index. An active fund can land above or below it.
- **The size of the fee gap.** The rupee example above shows how much of the difference is fee.

For large cap in particular, [large cap funds](https://koshex.com/mutual-funds/categories/large-cap-funds) has a section on large cap fund or index fund. [Index funds](https://koshex.com/mutual-funds/categories/index-funds) sets out how an index fund differs from an actively managed one. For the general checklist, see [how to choose the right mutual fund](https://koshex.com/blog/how-to-choose-the-right-mutual-fund-for-investment-goals).

Koshex reviews your holdings over time and flags changes, such as a fund's category, risk or ranking shifting.

## Can you hold both?

Yes. Many investors hold an index fund and an active fund together, and what matters is how much the two overlap and what each is for.

Overlap means the same companies sitting in both funds. Say an active large cap fund and a large cap index fund hold mostly the same shares. You have then bought the same thing twice and paid two fees. [Mutual fund diversification](https://koshex.com/blog/mutual-fund-diversification) shows how to check this.

Costs matter too, because the two fees differ. So do your goal and time frame. A fund for a goal ten years away has a different job from one for a goal two years away.

A SIP is not a third kind of fund. It is a way of putting money into any fund, active or passive, at regular intervals. [What is a SIP](https://koshex.com/blog/systematic-investment-plan-sip) explains how it works.

Koshex helps you choose a fund that suits your goal and timeline. You can browse the funds on [mutual funds](https://koshex.com/mutual-funds).

## Frequently asked questions

### What is the difference between active and passive mutual funds?

In an active fund, a manager chooses what to buy within SEBI's rules for the fund's category and tries to do better than an index. In a passive fund, the index decides what the fund holds. SEBI ties a passive fund to its index: at least 95% of its money must be in the index's securities.

### Is an index fund a mutual fund?

Yes. An index fund is a mutual fund scheme in SEBI's Index Funds/ETFs category, run by a SEBI-registered fund house. The choice is not mutual fund or index fund. It is active or passive.

### Are passive funds safer?

No. A fund's risk comes from what it holds, and an index fund falls when its index falls. The NIFTY 50 price index fell 38.4% between 14 January and 23 March 2020. Passive funds do remove the risk of a manager's own choices going wrong.

### Do active funds always charge more?

SEBI's ceiling is higher for an active equity fund: 2.10% on the first ₹500 crore, against 0.90% for an index fund. These are maximums, and actual fees vary by fund. Check the expense ratio of the scheme you are looking at.

### Can an active fund do worse than an index fund?

Yes. An active fund's return depends on the manager's choices, and its fee comes out of that return. That is why the comparison to make is returns after costs against an index fund on a comparable index.

### Can I hold both active and passive funds?

Yes. What matters is how much the two funds overlap, what each costs and what each is for. If both hold mostly the same shares, you have bought the same thing twice.

### Is a SIP a type of mutual fund?

No. A SIP is a way of investing a fixed amount at regular intervals. You can run one in any fund, active or passive.

*This article explains how things work; it is not advice to buy or sell any investment. Mutual fund investments are subject to market risks, read all scheme related documents carefully.*