Active funds are mutual funds in which professional fund managers decide which investments to buy, hold or sell. They use research and judgement to pursue the scheme’s objective, typically aiming to outperform a relevant benchmark. Better returns are not guaranteed.
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How do active funds work?
Your money is pooled with that of other investors and invested in shares, bonds or other securities according to the scheme’s objective. The fund manager researches investments, selects securities and monitors the portfolio. Holdings may change as valuations, company prospects or market conditions change. The fund’s returns reflect the performance of its investments after expenses. These returns are usually assessed against a relevant benchmark.
Source: AMFI, Types of Mutual Fund Schemes.
Key Takeaways
- Active funds rely on fund managers to select investments within the scheme’s stated investment limits.
- Actively managed funds are available across equity, debt, hybrid and international categories.
- Fund managers can adjust portfolios as conditions change, but their decisions may not deliver the intended results.
- Expenses reduce investor returns and should be assessed alongside performance and risk.
- Choose a fund category that suits your financial goals, investment horizon and risk appetite.
Types of active funds
Actively managed funds invest across different asset classes and strategies. Check the scheme documents to confirm its management approach, since some categories also include passive schemes.
Equity funds
Actively managed equity funds primarily invest in shares. These include large cap funds, mid cap funds and small cap funds, as well as schemes investing across company sizes.
Strategies also differ. Growth funds seek companies with scope for business expansion, while value funds look for shares trading below the manager’s assessment of their worth.
Bond funds
Bond funds invest in fixed-income securities, such as government and corporate bonds. Managers consider credit quality, interest rates and maturity when selecting investments.
Returns come from interest income and changes in security prices. The fund’s returns are not fixed or guaranteed.
ELSS funds
Equity Linked Savings Schemes (ELSS) invest at least 80% of their assets in equity and equity-related instruments. Each investment has a three-year lock-in, including each separate SIP instalment.
Under the old tax regime, eligible ELSS investments form part of the combined annual deduction limit of ₹1.5 lakh. For tax year 2026–27 onwards, this falls under Section 123 read with Schedule XV of the Income-tax Act, 2025, corresponding to Section 80C of the earlier Act.
Sector funds
Sector funds invest at least 80% of their assets in equity and equity-related instruments of a particular sector, such as healthcare or technology. This concentration makes their performance more dependent on developments affecting that industry.
Hybrid funds
Actively managed hybrid funds combine equity and debt, with some schemes investing in other permitted assets. Examples include aggressive hybrid funds, conservative hybrid funds, balanced advantage funds and multi asset allocation funds. Their risk depends on the asset mix and investment strategy.
International funds
Actively managed international funds invest in overseas securities, directly or through overseas funds. They provide exposure to foreign companies and markets but carry currency, market, geopolitical and regulatory risks.
Source: AMFI, Understanding Mutual Funds; Income Tax Department; Income-tax Act, 2025, Section 123 and Schedule XV; SEBI, Overseas Mutual Fund Investments, 4 November 2024.
Active funds vs passive funds
Active funds use the manager’s investment judgement, while index funds and ETFs follow a specified index:
| Aspect | Active funds | Passive funds |
| Investment selection | Managers choose securities within the scheme’s investment limits. | Index funds and ETFs seek to replicate their chosen index. |
| Portfolio changes | Reflect research, valuations and investment decisions. | Generally reflect changes in the underlying index. |
| Performance objective | Typically aim to outperform a benchmark. | Aim to track an index, allowing for expenses and tracking differences. |
| Costs | Generally higher because of research and active management. | Generally lower than comparable active funds. |
Both approaches carry investment risk. A passive fund’s risk depends on its underlying holdings; following an index does not automatically make it a low-risk investment.
Sources: AMFI, Types of Mutual Fund Schemes; SEBI Investor, Index Mutual Funds.
Advantages of investing in active funds
Here are the main benefits of investing in active funds:
- Professional research: Fund managers and analysts assess investments on your behalf.
- Portfolio flexibility and risk management: Managers can adjust holdings and exposures as conditions change, within the scheme’s investment limits.
- Opportunity to generate alpha: Active funds seek returns above their benchmarks through investment selection and portfolio decisions.
Limitations of active funds
Here are the main costs and risks to consider before investing in active funds:
- Higher expenses: Research, management and trading costs reduce net returns.
- Manager decisions can go wrong: Security selection and asset allocation may lead to underperformance.
- Market risks remain: Active management cannot eliminate losses caused by market movements, interest rate changes or credit problems.
Who should invest in active mutual funds?
Active mutual funds may suit investors who want professional investment selection and are comfortable with the associated costs and risks. Choose the fund category carefully. An active equity fund and a short-duration debt fund serve different needs, even though both are actively managed. Your investment horizon and risk appetite should match the scheme you select.
How to evaluate an active fund
Here are the main factors to check before choosing an active fund:
- Objective and strategy: Read the Scheme Information Document (SID) to understand what the fund invests in and how it selects investments.
- Performance: Compare returns with the benchmark and relevant category peers across comparable periods and different market conditions.
- Risk and holdings: Check whether the SEBI Riskometer level suits your risk appetite, and review concentration in individual companies, sectors and asset classes.
- Expense ratio: Compare the total expense ratio (TER) of the specific plan you intend to invest in.
- Fund manager and process: Review the manager’s experience, investment approach and stability of the investment team.
Past performance may or may not be sustained in future
Source: SEBI Investor, Understanding the Riskometer.
Taxation of active funds
Tax depends on the fund’s classification, purchase date and holding period. Active and passive funds follow the same rules when they belong to the same tax category. Capital gains generally arise when you redeem, sell or switch units. Tax applies to the gain, not the entire withdrawal. An increase in the value of units you continue to hold does not, by itself, trigger capital gains tax.
Capital gains tax on active funds
For resident individual investors, the following treatment generally applies in tax year 2026–27:
| Fund category | Holding period | Tax on gains |
| Equity-oriented funds | 12 months or less | 20% |
| Equity-oriented funds | More than 12 months | 12.5% on aggregate qualifying long-term gains exceeding ₹1.25 lakh in the tax year |
| Debt-oriented specified mutual funds, for units acquired on or after 1 April 2023 | Any period | Applicable income-tax slab rate |
| Other non-equity funds outside the specified mutual fund rules, with unlisted units | 24 months or less | Applicable income-tax slab rate |
| The same other non-equity funds | More than 24 months | 12.5% without indexation, meaning no inflation adjustment to the purchase cost |
The equity rates are subject to applicable securities transaction tax conditions. For listed non-equity units outside the specified mutual fund rules, the long-term holding threshold is more than 12 months. Applicable surcharge and 4% health and education cess are additional.
The ₹1.25 lakh threshold is shared across qualifying long-term gains from equity-oriented funds, listed equity shares and business trust units. It is not a separate allowance for each fund and does not apply to non-equity fund gains.
Source: Income Tax Department, Income-tax Act, 2025, Sections 2(101), 76 and 196–198.
Which tax category applies to your fund?
Here is how debt, hybrid and international active funds are classified for tax purposes:
- Debt funds: The specified mutual fund rules cover funds investing more than 65% in debt and money market instruments, and funds investing 65% or more in units of such funds, measured using the prescribed annual average. Units purchased before 1 April 2023 fall outside the acquisition-date rule; these older holdings generally attract 12.5% long-term capital gains tax without indexation when redeemed in tax year 2026–27.
- Hybrid funds: Their qualifying asset allocation determines whether equity-oriented, specified mutual fund or other non-equity rules apply.
- International funds: Overseas equity investments do not automatically qualify for Indian equity-oriented taxation. International equity funds generally follow the other non-equity rules unless they meet another applicable tax definition.
Source: Income Tax Department, Income-tax Act, 2025, Sections 76, 197 and 198(8).
Tax on IDCW payouts
Income Distribution cum Capital Withdrawal (IDCW) payouts are added to your taxable income and taxed at your applicable slab rate.
For residents, TDS generally applies at 10% when aggregate IDCW income from the mutual fund exceeds ₹10,000 in the tax year, subject to applicable exemptions and PAN requirements. It applies to the full qualifying amount once the threshold is crossed.
TDS can be claimed as a credit against your final tax liability. Payouts below ₹10,000 can still be taxable even if no TDS is deducted.
Source: Income Tax Department, Income-tax Act, 2025, Section 393(1), Table 4(i).
The tax information in this article is based on prevailing laws at the time of publishing the article and is subject to change. Please consult a tax professional or refer to the latest regulations for up-to-date information.
Conclusion
Active funds give investors access to professional research and investment decisions within a defined strategy. Choosing one involves looking beyond its recent returns. Consider what the scheme invests in, the risks it takes, its costs and how it fits your financial goals.
FAQs
Do active funds always beat the index?
No, actively managed mutual funds do not always outperform their benchmark indices. Their performance depends on factors such as portfolio decisions, market conditions, expenses and investment strategy.
Can I invest in active funds through SIP?
Yes, eligible open-ended active mutual fund schemes accept investments through a Systematic Investment Plan (SIP). Check the scheme’s minimum instalment amount and available frequencies.
How can I tell whether a mutual fund is active or passive?
Check its investment objective and strategy in the SID or Key Information Memorandum (KIM). These documents explain whether the scheme selects investments actively or follows an index.
How can I buy actively managed mutual funds?
You can buy actively managed mutual funds through the AMC’s website, a registered mutual fund distributor or an authorised investment platform. Complete the KYC requirements, select the scheme and plan, and choose an available SIP or lump sum facility.
What is the average fee for an active mutual fund?
There is no single fee across active funds. Check the specific scheme and plan’s latest TER, which reflects recurring expenses. Review the exit load separately, as it may apply when you redeem units.
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