Passively managed index funds, which are supposed to mimic the returns of underlying indices, albeit the tracking error, often outperform the actively managed funds. Furthermore, they are less expensive and less volatile than their actively managed counterparts.

Let us be candid about investing. Even the keenest of the market observers do not exactly know what is going to happen in the stock market next week, next month, or next year. However, it is hoped that in the long run (say, 20 years or more), global economic growth would create expansion of corporate earnings, and that would in turn create stock market wealth. So, it is often safe to take an unimpassioned approach to market behavior and not try to outguess the market by picking up some individual stocks/sectors which are indeed erratic in nature. Instead, it is often recommended by many experts to sit passively, sleep well, and rely on the possible upswing in the broader market index. These passively managed index funds are relatively safer than the actively managed funds which keep a constant vigil on the movement of the stocks and vehemently try to beat the market. And in many cases, these professionally managed funds end up with lower returns than that of the broader index. According to the newly introduced S&P Crisil Indices versus Active Fund (SPIVA) scorecard for the Indian mutual fund industry, 70% of large cap funds in India underperformed the S&P CNX Nifty Index. Further, 40% of the funds in the diversified equity category underperformed the S&P CNX 500 Index over a five-year period ended December 2009. Indeed, in the world of investing, a greater intelligence does not necessarily lead to a better investing performance. So it makes sense to remain idle and invest in passively managed index funds.

Index funds, which are quite popular in the developed world, merely invest in the securities in the broader index. It is passive, in the sense that absolutely no attempt is made to outperform the prime market index. It involves tracking an index, say, for example, the 30-share Sensex or the 50-share Nifty and building a portfolio with the same stocks in the same weights as the index. These funds completely rely on computer model with minimal human intelligence in the decision making as to which stocks to be bought or sold, and are therefore considered as `passively managed'.

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