What are active funds?
Team FINWEL · 30 Jul 2026 · 4 min read
An active fund employs a manager and a research team to decide what the fund holds, with the objective of doing better than a stated benchmark. That is the whole proposition, and everything else about an active fund follows from it.
The mandate comes first
A fund manager in India does not have a free hand. SEBI's scheme categorisation framework defines what each category may hold, and a fund must stay inside its category. A large cap fund must keep a minimum proportion in large cap companies. A mid cap fund must do the same for mid caps. The definitions of large, mid and small cap follow a market capitalisation ranking published twice a year by AMFI.
This matters more than most investors realise. A large cap fund that falls behind cannot rescue its numbers by buying small caps, because the mandate does not allow it. So when you buy an active fund you are buying a manager's judgement within a defined universe, not a free-ranging search for returns.
What the manager is actually doing
Research, portfolio construction and position sizing. The manager forms a view on which companies will do better than the market expects, decides how much conviction to express in each, and manages the risk of being wrong.
The measure of how different the portfolio is from the benchmark is sometimes called active share. A fund whose holdings closely resemble its index cannot beat that index by much after costs, whatever the manager intends. A fund that differs substantially can beat it or trail it by a wide margin.
Cost, and the direct versus regular distinction
Active management costs money. Research teams, dealing desks and the manager's time are paid for through the total expense ratio, deducted daily from the net asset value.
Every scheme in India is available as a direct plan and a regular plan. The regular plan includes distributor commission in its expense ratio and the direct plan does not, so the direct plan has a lower expense ratio and a higher net asset value over time for the same underlying portfolio.
We say that plainly because it is a fact an investor is entitled to, and because FINWEL is a distributor. What a distributor provides in return for that commission is service, paperwork, continuity and someone to call. Whether that is worth the difference is your judgement to make, not ours to assume.
The measures used to judge an active fund
Returns alone say little, because they do not distinguish skill from risk taken. The common measures attempt to separate the two.
| Measure | What it attempts to show |
|---|---|
| Alpha | Return above what the benchmark and the risk taken would explain |
| Beta | How much the fund moves relative to its benchmark |
| Standard deviation | How much the returns vary from their own average |
| Sharpe ratio | Return above the risk-free rate per unit of total volatility |
| Sortino ratio | The same idea, counting only downside volatility |
Every one of these is calculated over a chosen period against a chosen benchmark, and both choices change the answer. Treat them as questions to ask rather than scores to rank by.
The risks specific to active management
- Manager risk. Results depend on individuals, and individuals move on
- Style drift. A fund may gradually behave differently from what its name and history suggest
- Size. A strategy that worked on a small asset base can become harder to run as the fund grows, particularly in less liquid segments
- Concentration. High conviction cuts both ways, and the same positions that produce a good year produce a bad one
- Cost certainty against return uncertainty. The expense ratio is charged whether or not the manager beats the benchmark
What to look at before you buy one
- The category and mandate, so you know what universe the manager is working in
- How long the current manager has been running the fund, and whose record the track record is
- Whether the portfolio matches the stated strategy
- The expense ratio, and whether you hold a direct or a regular plan
- Performance across full market cycles rather than a single strong or weak year
- Whether the benchmark used in the fund's own reporting is appropriate
An active fund is a decision to pay for judgement. That can be a reasonable decision. It is a decision worth making deliberately rather than by default.
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