Passive Funds Fail to Cushion Market Correction, Active Strategies Outperform

In a surprising turn of events, passive funds that were expected to cushion portfolios during market downturns have failed to meet investor expectations in the recent market correction. While low-volatility strategies were considered a reliable option to navigate turbulent times, data shows that many smart beta funds and passive investment strategies have performed worse than their market-cap-weighted indices during the recent market slump.

Invest in Indian Markets and Unlock Future Potential With 5paisa!

Open Account Now

The Market Downturn

The National Stock Exchange’s (NSE) benchmark Nifty 50 index has been on a downward trajectory since hitting a fresh all-time high on September 27, 2024. Amid this correction, several passive funds, including low-volatility and smart beta funds, failed to deliver the protection and returns that investors were hoping for.

For instance, the Nifty Alpha Low-Volatility 30 Index, designed to combine alpha generation with low volatility, slumped by 24.3% as of February 28, 2025. This is in stark contrast to the Nifty 50 index’s decline of just 15.60% during the same period. Investors had hoped that the inclusion of low volatility would help mitigate losses in a bear market, but these funds have underperformed their comparative indices.

Similarly, other low-volatility strategies like the Nifty Quality Low-Volatility 30 Index and Nifty Alpha Quality Low-Volatility 30 Index also struggled to outperform the Nifty 50 index in this downturn.

Why Didn’t Passive Funds Perform?

One reason behind the poor performance of these passive funds is the reliance on back-tested data. The design of smart beta indices assumes that past performance in managing volatility will repeat in future market conditions. However, volatility in the market doesn’t always follow a predictable pattern, and past performance doesn’t guarantee future results, as highlighted by Kirtan Shah, founder of Credence Wealth.

Additionally, while passive funds such as index funds and exchange-traded funds (ETFs) have seen significant growth in assets under management (AUM), totaling Rs 10.91 lakh crore as of January 2025, their performance has been lackluster during the recent correction.

Active Funds Outperforming

On the other hand, active funds have shown more resilience in this market environment. Data from ACE MF indicates that active small-cap funds have outperformed the Nifty Smallcap 250 index during the correction. Additionally, some active flexi-cap and multi-cap funds have beaten the returns of the Nifty500 index, their benchmark.

This performance divergence suggests that active fund managers, with their ability to make decisions based on current market conditions, are better positioned to navigate market corrections. As Amol Joshi, founder of Plan Rupee Investment Services, explains, passive funds are not meant to outperform in either bull or bear markets. While they offer lower fees and transparency, they usually deliver returns that closely mirror their underlying indices, including during market declines.

Conclusion

In conclusion, while passive funds have seen a rise in popularity, especially with their low expense ratios, the recent market correction has shown that they may not always provide the downside protection that investors expect. Active funds, with their flexibility and ability to adjust strategies according to market conditions, have proven to outperform in this scenario. However, it's important for investors to understand that both passive and active funds have their place in a portfolio, depending on market conditions and individual risk tolerance.