Index funds suffer from three key disadvantages owing to their passive style. They don’t offer flexibility to the fund manager in managing market downsides. If the index being replicated by the fund is generating negative returns due to unfavourable economic or market conditions, an active fund manager has the option to choose stocks to better manage the downside. But an index fund must follow the benchmark, both during market up and downswings.
An active fund manager tries to generate alpha i.e. an excess return over the fund’s benchmark. Hence active funds can generate returns higher than their benchmark by taking additional risk. But index funds are low-risk products that simply mimic an underlying benchmark. Hence an investor seeking return in excess of the benchmark index should avoid an index
Read more