Summary of this article
Index funds are simple, ETFs offer additional cost advantages but need sufficient liquidity and tight spreads on iNAV.
Historical performance data indicates that most active funds underperform their benchmarks on an after-fee basis. This is particularly true in large and mid-cap funds.
Some small-cap active funds have produced alpha, but frequent churn and higher fees can kill gains from active management.
Before the active versus passive debate, there's a simpler distinction that investors often skip: index funds versus ETFs (exchange-traded funds). Both track the same benchmark, but the mechanics differ.
Index fund units are bought and sold through the mutual fund house at the end-of-day NAV; ETF units trade on the exchange throughout the day, like a stock. ETFs are typically a shade cheaper on expense ratio, but that saving only holds if the ETF is genuinely liquid.
“Trading volume matters here in a way it doesn't for index funds, because a thinly-traded ETF can see its market price drift away from its intraday NAV (iNAV). The wider that gap, the riskier the trade: you could end up buying above fair value or selling below it, quietly giving back the cost advantage ETFs are supposed to offer,” says Rajani Tandale, SVP – Mutual Fund & Partner at 1 Finance.
The practical rule: if you can't check an ETF's trading volume and iNAV spread before buying, the index fund is the safer default.
The Bigger Question - Active Vs Passive
The debate has moved from theory to arithmetic, and the numbers, tracked over decades by S&P's SPIVA Scorecard, are stark. Over a 20-year period, 92 per cent of U.S. large-cap active funds underperformed the S&P 500 after fees, with underperformance climbing steadily the longer you hold, 94 per cent for mid-cap, 93 per cent for small-cap, 91 per cent for international equity.
“This isn't really a mystery, it's math. Active and passive investors together own the whole market. So, before costs, the average active dollar must earn exactly the market return; after fees, active management underperforms by roughly what it charges. The SPIVA India Score card also showcases the same story 70 per cent to 80 per cent underperformance in large-cap, ELSS, midcap and smallcap. So, shrinking of alpha generation is not just India’s problem,” informs Tandale.
India's own data, tracked quarterly by 1 Finance Magazine, tells a more textured version of the same story. On trailing 5-year returns, large-cap regular plans have underperformed their benchmark at rates as high as 92 per cent (March 2023) and were still running 50-56 per cent as of mid-2026, consistently 15-25 percentage points worse than direct plans of the identical scheme in the same quarter. That gap is pure distributor-commission drag, and it's the cleanest real-world illustration of the SPIVA arithmetic at work: same fund manager, same stock picks, different fee load, dramatically different odds of beating the index.
The 10-year numbers are more damning still. Mid-cap regular plans hit 100 per cent underperformance across all four quarters of 2025, literally every mid-cap regular-plan fund with a decade-long track record failed to beat its benchmark. Large-cap regular plans weren't far behind, at 83-87 per cent.
One genuine nuance pushes back against the "passive always wins" headline: small-cap direct plans. Over 10 years, their underperformance has run as low as 8-15 per cent through 2025-26, meaning most small-cap direct funds have actually beaten their benchmark over a decade, even as small-cap regular plans (23-31 per cent) and every large/mid-cap category told the opposite story.
“This tracks with the standard explanation - thinner analyst coverage in small-caps leaves more room for genuine research edge. But that edge is only realised if an investor actually stays put for the full decade. In practice, most don't: a couple of years of underperformance or a sharp drawdown is usually enough to trigger a switch, and that behaviour gap quietly erases whatever edge the fund might have delivered to a patient holder,” says Tandale.
Even large-cap direct plans show how noisy this can get short-term - underperformance swung from a low of 25 per cent (March 2024) to a high of 60 per cent (March 2025) within a single year, a reminder that even a broadly "efficient" category doesn't move in a smooth, one-way line.
That is really the crux of it: plenty of active funds may well be good managers in the long run. But underperformance, even for a few years, occupies real mental space, and that's precisely when investors give up on the fund. “The risk of switching funds repeatedly, chasing whoever looks good this year, is usually a far more costly mistake than the no-alpha generation with index funds. Passive doesn't just remove the fee drag; it removes the temptation to switch in the first place,” says Tandale.
