Index Funds vs Active Funds: Where Active Still Wins in India

In calendar year 2025, the S&P India SmallCap index fell 7.9%.

The average actively managed Indian mid- and small-cap fund fell 0.7%.

That gap — roughly seven percentage points of avoided pain — is why the "just buy an index fund" advice, which is correct for most Indian investors most of the time, is not correct for all Indian investors all of the time. In that same year, only 12.1% of active mid-/small-cap funds underperformed their benchmark. Put the other way: 87.9% of them beat it. S&P Dow Jones Indices called it the category's best relative showing since 2014.

Now hold that thought, because here is the other half of the same report. Over the same one-year period, 75% of active large-cap funds lost to their benchmark. Over ten years, 76.3% lost. Over five years, 84.4% lost.

Two categories. Two opposite verdicts. Same report, same publisher, same methodology.

Most Indian articles on this subject pick one of those numbers and build a sermon around it. This one uses both, because the honest answer to "index or active?" in India is not a preference — it is a map. There are parts of the market where active management has been a losing proposition for a decade, and there are parts where it still earns its fee. Knowing which is which is worth more than any fund recommendation.

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First, the scoreboard

The SPIVA India Scorecard (S&P Indices Versus Active) is the closest thing India has to an unbiased referee. It compares every active fund in a category against the appropriate benchmark, corrects for survivorship bias — funds that were quietly merged or shut down are counted, not forgotten — and reports one number: the percentage of active funds that underperformed.

Here is the Year-End 2025 edition, with data as of 31 December 2025. I have flipped SPIVA's numbers to show the percentage of active funds that beat the index, because that is the number you actually care about when you are choosing a fund.

Read that chart slowly, because it contains the entire argument.

Large-cap is settled. At every single horizon — one year, three, five, ten — roughly three-quarters or more of active large-cap funds lost to the index. There is no horizon at which the majority won. This is not a bad patch. It is a decade-long, structural result.

Mid- and small-cap is not settled. The majority of active funds beat the index over one year (87.9%), three years (58.5%), and five years (54.0%). Only at the ten-year mark does the index pull ahead, with 79.0% of active funds falling behind.

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Why large-cap active management stopped working

The Nifty 50 is fifty of the most scrutinised companies on earth. Every brokerage in Mumbai publishes research on them. Every foreign institutional investor models them. Every earnings call is transcribed within minutes.

An active large-cap manager, by SEBI's own definition, must hold at least 80% of their portfolio in the top 100 companies by market capitalisation (SEBI circular SEBI/HO/IMD/DF3/CIR/P/2017/114, 6 October 2017, which defines large-cap as ranks 1–100, mid-cap as 101–250, and small-cap as 251 onwards). So the manager is picking from the same fifty-to-hundred names as everyone else, using the same public information, and charging you for the privilege.

Then there is the arithmetic that no amount of skill can repeal.

Under the new SEBI (Mutual Funds) Regulations, 2026 — effective 1 April 2026 — an actively managed open-ended equity fund can charge a base expense ratio of up to 2.10% (for schemes under ₹500 crore of assets), sliding down to 0.95% for schemes above ₹50,000 crore. An index fund or ETF is capped at 0.90%, down from the previous 1.00% ceiling.

But the caps are not what investors actually pay. Real Nifty 50 index funds, direct plan, charge a fraction of the cap:

An active large-cap fund charging, say, 1.00% in its direct plan must therefore out-pick the index by roughly 0.8 percentage points every single year, gross, before it delivers you a single rupee more than a 0.20% index fund. Over twenty years that is a hurdle it must clear twenty times in a row. The SPIVA data tells you how often it happens: about a quarter of the time.

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The fee gap, in rupees

Percentages hide the damage. Rupees do not.

Below, set your own assumptions. The default shows a ₹25,000 monthly SIP over 20 years, with both funds earning the same 11.2% gross return — meaning the active manager adds zero alpha, neither skilled nor unskilled. The only difference is the fee.

Leave the sliders at their defaults and the answer is stark. On ₹60 lakh of contributions, a 0.8-percentage-point fee gap with zero difference in stock-picking skill costs roughly ₹21.9 lakh over twenty years. The active fund does not have to be badly managed to lose. It only has to be ordinary.

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So where does active still win?

Now turn the sliders back and let us be equally honest in the other direction. Three arguments for active management survive contact with the Indian data. One of them is much stronger than the other two.

1. The mid- and small-cap market is genuinely less efficient

SEBI defines small-cap as every listed company ranked 251st or below by market capitalisation. That is not a tidy list of fifty household names — it is a long tail of hundreds of companies, many with thin analyst coverage, patchy disclosure, and low liquidity. Information asymmetry is real there in a way it simply is not for HDFC Bank.

The scorecard reflects this. Over one, three, and five years to December 2025, the majority of active mid-/small-cap funds beat their benchmark. Over ten years, they did not. Both facts are true, and the tension between them is the most interesting thing in this article — we will come back to it.

2. In a falling market, active mid/small-cap funds held up dramatically better

2025 was the stress test. The S&P India SmallCap fell 7.9% over the calendar year. Active mid-/small-cap funds, as a category, fell 0.7%.

An index fund is contractually obliged to own the falling thing. Its mandate is to track, not to think. A manager holding cash, or avoiding the frothiest micro-caps, or simply refusing to buy a company at 60x earnings, has an option the index does not have — the option to abstain.

3. The strongest argument: risk-adjusted returns

Here is where the ten-year puzzle resolves, and it is the part almost nobody writes about.

Over ten years, most active mid-/small-cap funds underperformed the index on raw returns — 79.0% of them in the Year-End 2025 edition. But SPIVA also publishes a risk-adjusted scorecard, which divides each fund's return by the volatility it took to get there.

Compare the two within a single edition, so it is a fair fight. In the Mid-Year 2025 scorecard (data to 30 June 2025), 81.7% of mid-/small-cap funds underperformed on raw returns over ten years. On risk-adjusted returns over the same period, against the same funds, only 48.3% underperformed. Over five years the split is even starker: 67.3% on raw returns, 24.5% risk-adjusted.

Read that again. On raw returns, most active mid/small-cap funds lose. On risk-adjusted returns, most of them win.

There is only one way both statements can be true: active mid/small-cap funds deliver slightly lower returns while taking substantially less risk. They lag the index on the way up and lose far less on the way down — exactly what the 2025 numbers showed in real time.

If you are twenty-five and your small-cap allocation is money you will not touch for thirty years, the index's extra volatility is a price worth paying and you should probably index. If you are fifty-two, and a 40% drawdown five years before retirement would change the age at which you retire, you are buying something real when you pay a mid-cap manager. The risk-adjusted column is what you are buying.

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What are your actual odds?

Here is the same SPIVA data with the marketing removed. Pick a category and a horizon. Each dot is one active fund.

Notice what happens as you extend the horizon on the mid- and small-cap tab. Your odds are magnificent at one year, good at three, a coin-flip at five, and poor at ten. Alpha in India has a half-life. Funds that beat the index do so in bursts, then their assets swell, their nimbleness disappears, and the arithmetic of size catches up with them.

The ten-year number also hides something SPIVA is careful to measure: over the ten years to June 2025, roughly 30% of Indian funds across all categories were merged or liquidated. The fund you would have picked in 2016 had a meaningful chance of not existing in 2026 — and it did not close because it was winning.

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Two things about index funds that nobody puts on the fact sheet

Index investing is the right default for most people. It is not risk-free, and two of its risks are specific to India right now.

The Nifty 50 is not as diversified as it sounds

"Fifty stocks" implies spread. The weights say otherwise.

Just over half the index sits in ten companies, and more than a third of it — 37.00% — is a bet on Indian financial services. Two banks alone, HDFC Bank and ICICI Bank, account for 20.19% of every rupee you put into a Nifty 50 index fund. If Indian banking has a bad decade, your "diversified" index fund will have one too, and it will hold every share of it the whole way down, because that is what it promised to do.

An active manager can be underweight financials. That is not automatically valuable. But it is not nothing, either.

The index fund also charges you, quietly

An index fund does not deliver the index. It delivers the index minus its expense ratio, minus its trading costs, minus the small drag from cash held for redemptions. SEBI requires that an equity index fund's tracking error stay under 2% annualised (circular SEBI/HO/IMD/DOF2/P/CIR/2022/69, 23 May 2022). Large Nifty 50 funds run well inside that limit — but "tracks the index" and "matches the index" are different sentences.

Your index fund is guaranteed to underperform its benchmark, by roughly its cost, forever. That is the deal, and it is a good deal. It is just not a free one.

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The India-specific point that changes the American answer

Almost everything written about index funds in India is a translation of an American argument. One important piece of that argument does not survive the journey.

In the United States, a mutual fund is a "regulated investment company" and must, under 26 U.S. Code § 852, distribute its realised capital gains to shareholders each year. Those distributions are taxable to the shareholder whether or not they sold anything. So a high-turnover American active fund hands its investors a tax bill every December for trades they never made. That structural tax drag is one of the most powerful arguments for indexing in the US, and it is why "tax-efficient" is practically a synonym for "passive" in American writing.

India does not work this way.

Under Section 10(23D) of the Income Tax Act, the income of a SEBI-registered mutual fund is exempt from tax at the fund level. When your fund manager sells a stock at a profit, nothing is passed through to you, and nothing is taxed. You are taxed only when you redeem your own units.

The consequences are precise:

• An Indian active fund manager can turn the portfolio over completely, every year, and it costs you zero in tax.
• Index funds and active equity funds are taxed identically: both are equity-oriented schemes. Short-term gains (units held under 12 months) are taxed at 20% under Section 111A. Long-term gains are taxed at 12.5% above a ₹1.25 lakh annual exemption, under Section 112A.
• Therefore, in India, the case for index funds rests on cost and consistency alone. The tax argument, which does so much work in the American version, does no work here.

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Where India's money is actually going

For all the debate, the market has been quietly voting. As of 31 March 2026, passive schemes — index funds, ETFs, gold ETFs and overseas funds-of-funds — held ₹14.12 lakh crore, about 19% of the entire Indian mutual fund industry's ₹73.73 lakh crore of assets. Index funds alone accounted for ₹3.07 lakh crore across 360 schemes and 1.50 crore folios.

Two months later, industry assets had recovered to ₹81.58 lakh crore, and monthly SIP contributions hit ₹30,954 crore.

But note the date. That ₹73.73 lakh crore figure for March 2026 was down from ₹82.03 lakh crore at the end of February — a 10.1% fall in a single month, caused almost entirely by market prices rather than redemptions, as the Nifty 50 dropped roughly 9.4% in March 2026.

Which brings the whole argument back to where it started. In that kind of month, an index fund gives you the market's full drop, precisely and honestly, because that is exactly what it agreed to do. Whether you want anything else — and whether you are willing to pay for it, and whether the person you pay is any good — is the entire question.

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The honest framework

Not a preference. A map.

Both sides of this argument have been oversold to you. The index-fund evangelist who tells you active management never works has not read the mid-cap risk-adjusted column. The distributor who shows you a fund that returned 22% has not shown you the thirty funds in the same category that did not, or the ones that closed.

The data does not support a slogan. It supports a boundary — and the boundary runs straight through the middle of your portfolio.

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Frequently Asked Questions

Are index funds better than actively managed funds in India?

In large-cap, yes, clearly. According to the SPIVA India Year-End 2025 scorecard, 75.0% of active large-cap funds underperformed their benchmark over one year, 74.2% over three years, 84.4% over five years, and 76.3% over ten years. There is no horizon at which the majority of active large-cap funds win. In mid- and small-cap, the answer is different: 87.9% of active funds beat the index over one year, 58.5% over three years, and 54.0% over five years. Only over ten years does the index win, with 79.0% of active funds underperforming.

How much does a higher expense ratio actually cost over 20 years?

More than most investors imagine. On a ₹25,000 monthly SIP over 20 years (₹60 lakh invested), assuming both funds earn the same 11.2% gross return, an index fund charging 0.20% would build about ₹2.18 crore while an active fund charging 1.00% would build about ₹1.96 crore. The difference is roughly ₹21.9 lakh — around a third of everything you contributed — created entirely by the fee, with no difference at all in the manager's skill. The active fund must generate 0.8% of extra gross return every year just to break even.

Where do actively managed funds still beat index funds in India?

Three places, in order of evidence strength. First, risk-adjusted returns in mid- and small-cap: SPIVA's Mid-Year 2025 risk-adjusted scorecard shows only 24.5% of these funds underperformed over five years and 48.3% over ten, meaning most beat the index once you account for the volatility taken. Second, falling markets: in calendar 2025 the S&P India SmallCap fell 7.9% while the average active mid-/small-cap fund fell just 0.7%. Third, market inefficiency: SEBI classifies small-caps as companies ranked 251st and below by market cap, a long tail with thin analyst coverage where genuine information advantages still exist.

Are index funds and active funds taxed differently in India?

No. Both are equity-oriented schemes and taxed identically. Short-term capital gains on units held under 12 months are taxed at 20% under Section 111A. Long-term capital gains on units held 12 months or more are taxed at 12.5% above a ₹1.25 lakh annual exemption, under Section 112A. Importantly, under Section 10(23D), an Indian mutual fund pays no tax on gains it realises inside the scheme, and those gains are not passed through to you. This differs from the United States, where funds must distribute realised gains annually. It means high portfolio turnover in an Indian active fund creates no tax bill for you — so the American "index funds are more tax-efficient" argument does not apply in India.

How concentrated is the Nifty 50, really?

More than its name suggests. As of the NSE Indices factsheet dated 30 June 2026, the top ten constituents account for 53.58% of the index. Financial services alone make up 37.00% of it. HDFC Bank (11.18%) and ICICI Bank (9.01%) together represent 20.19% of every rupee invested in a Nifty 50 index fund. An index fund must hold these weights regardless of valuation, which is the trade-off you accept in exchange for its very low cost.

What is a closet index fund and how do I spot one?

A closet index fund is an actively managed fund that charges active-management fees while holding a portfolio nearly identical to its benchmark. You receive index-like returns minus a fee several times higher than an index fund would charge. To spot one, compare your fund's top ten holdings and their weights against the benchmark index's top ten. If they largely match, you are paying for active management you are not receiving. This is most common among large-cap funds, which is one reason the category's SPIVA results are so poor.

Should I switch my existing active funds to index funds?

Not automatically, because switching is a taxable event — redeeming triggers capital gains tax, and that cost is immediate and certain while the future fee saving is gradual. Evaluate each fund against its own benchmark over three and five years, and check whether it is a closet index fund quietly charging active fees for index-like holdings. For large-cap holdings that have consistently trailed their benchmark, a phased switch that uses the ₹1.25 lakh annual long-term capital gains exemption is usually more efficient than redeeming everything at once. Get the sequencing reviewed before you redeem anything — a badly timed switch can cost more in tax than it saves in fees.

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Sources

Every figure in this article comes from one of the following. Where an edition or factsheet date is given, that is the as-of date of the data, not the date it was published.

• S&P Dow Jones Indices, SPIVA India Scorecard — Year-End 2025 (data as of 31 December 2025). Source of all large-cap and mid-/small-cap underperformance rates, the 2025 calendar-year returns for the S&P India LargeMidCap (+8.9%) and S&P India SmallCap (−7.9%), and the corresponding active-fund category returns (+7.3% and −0.7%).
• S&P Dow Jones Indices, SPIVA India Scorecard — Mid-Year 2025 (data as of 30 June 2025). Source of all risk-adjusted underperformance rates, the ELSS figures, and the survivorship statistic that roughly 30% of funds across categories were merged or liquidated over ten years. The risk-adjusted scorecard is drawn from this edition because the Year-End 2025 risk-adjusted tables could not be independently verified at the time of writing.
• NSE Indices, Nifty 50 Factsheet, 30 June 2026. Constituent weights, the 53.58% top-ten concentration, the 37.00% financial services weight, and the index P/E of 20.58.
• AMFI Monthly Report, March 2026, and AMFI industry AUM disclosures for May 2026. Passive and index-fund AUM, scheme and folio counts, industry AUM, and the ₹30,954 crore May 2026 SIP figure.
• SEBI (Mutual Funds) Regulations, 2026, effective 1 April 2026, for the 0.90% expense cap on index funds and ETFs and the 0.95%–2.10% band for active open-ended equity schemes. SEBI circular SEBI/HO/IMD/DOF2/P/CIR/2022/69 (23 May 2022) for the 2% tracking-error limit. SEBI circular SEBI/HO/IMD/DF3/CIR/P/2017/114 (6 October 2017) for the large/mid/small-cap definitions.
• Income Tax Act, 1961 — Sections 111A, 112A and 10(23D). 26 U.S. Code § 852 for the US distribution requirement.
• Expense ratios for individual Nifty 50 index funds are as listed on 8 July 2026 and change over time.

A note on method: the ₹21.9 lakh fee-drag figure and every number produced by the calculators on this page are computed from the assumptions you can see and change on screen. They are arithmetic, not forecasts. Category-wide historical frequencies, such as the SPIVA beat rates, describe what has already happened and carry no promise about what will.

This article is for education, not investment advice. Mutual fund investments are subject to market risk; read all scheme-related documents carefully. Past performance does not indicate future returns. No fund named here is a recommendation.

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