Portfolio rebalancing: Active vs passive funds

Markets have seen topsy-turvy period in the past one year and despite the recent recovery, market participants remain cognisant that there may be further volatility to come in the near future. With this, one would inevitably be wondering about the classic question around active and passive funds while rebalancing their portfolios.

On the one hand, active funds provide the flexibility for fund managers to pick 'quality' stocks while avoiding stocks or sectors which may underperform. Passive funds, on the other hand, deliver close to market returns without the risk of human bias.

In our opinion, while both are valid arguments, it is a case of oversimplification without digging deeper within each category. The ideal way to realign a portfolio in a volatile market would be to orient it towards defensive strategies which protect downside.

Quantitative and qualitative research can help in understanding funds better like understanding a fund's investment strategy and style, while using data to gauge risk management using ratios like beta, downside capture, standard deviation and historical draw downs.

Taking an example within the passive funds category using Nifty, low volatility and quality Indices. Annualized volatility over the past 10 years has been 17 per cent, 13 per cent and 14.5 per cent respectively, suggesting that low volatility and quality are better in protecting from market volatility compared to Nifty.

Similar exercises with more data points and funds can be undertaken to identify the strategies which are better placed to perform well and create an optimum mix to navigate the portfolio in a volatile environment.

(The author is Co-founder and Joint Managing Director at Tailwind Financial Services)