Passive Portfolio Management

Passive portfolio management is a strategy used by index funds. It aims to match the returns of a specific index by minimizing active management and simply replicating the index's performance.
Passive Portfolio Management
3 min

Passive portfolio management is a strategy used by index funds, where the fund purchases and sells stocks to replicate or closely track a market index or benchmark. As an investment strategy, passive portfolio management aims for long-term gains and minimising risks by creating a portfolio in the likeness of a market index. The primary objective here is to mimic the growth of the index, not outperform it.

Given the crucial role that passive portfolio management plays in investing, it becomes imperative to know what passive portfolio management is, its advantages and disadvantages compared to other methods of portfolio management, various underlying strategies, and the different types of passive portfolio management.

What is passive portfolio management?

Think of passive portfolio management as a more hands-off approach to investing in mutual funds and creating a portfolio. Compared to active portfolio management, passive portfolios are not managed extensively, as the objective is to make profits over the long haul. With this primary goal in mind, passive portfolios are designed to move according to a market index or asset class. The portfolio is diverse, with reduced risks and costs. As a passive portfolio looks similar to a market index, the goal is also to copy the performance of the market and not necessarily surpass it. In this portfolio management style, individual stocks may not require monitoring, and you can manage by only monitoring the market index. Even the stocks picked and trades made follow a set of predetermined rules or algorithms, minimising human intervention.

Advantages of passive portfolio management

Passive portfolio management can be incredibly appealing to young investors who lack the knowledge and skills to gain an advantage with active management in the short term. It is also a good fit for investors who value long-term growth and low management costs. With this in mind, let us take a look at some of the major advantages of passive portfolio management.

1. Low costs

As there is limited trading and analysis is typically conducted only on the market index being followed, passive portfolio management offers investors a low-cost management alternative.

2. Consistency

Such portfolios also consistently keep the investor exposed to a broad market, ensuring that market fluctuations have a limited impact on the performance of their portfolio.

3. Tax efficient

Under passive portfolio management, there are fewer short-term capital gains owing to reduced trading, making these portfolios more tax-efficient.

4. Diversification

Modelled after a market index, portfolios under passive portfolio management are inherently diverse.

5. Accessibility

Passive portfolio management services are widely offered by exchange-traded funds (ETFs) and index funds, with minimum investments starting at Rs. 500.

What are strategies for passive portfolio management?

With the myriad benefits that passive portfolio management offers, let us also look at a few prominent strategies under its umbrella that investors and fund managers rely on.

1. Index investing

As the name suggests, this strategy is centred around following a market index like the BSE 500. This ensures that investors get exposure to the market at a low cost, albeit at the cost of flexibility.

2. Asset allocation

This strategy focuses on the diversification of a portfolio across asset classes like bonds and stocks for better risk management and stable returns over the long term. It can be customised to fit your financial goals and risk appetite. However, it does necessitate constant monitoring.

3. Buy-and-hold investing

Simply put, in this strategy of passive portfolio management, assets are bought and held with a long-term perspective from the very beginning. There is minimal trading, hence minimal costs. The aim here is to benefit from compounding returns in the long run.

Disadvantages of passive portfolio management

Here are a few drawbacks of the passive portfolio management strategy.

1. Limited flexibility

Naturally, with limited trading and a set of predefined rules in place, passive portfolio management is less flexible and lacks adaptability to market fluctuations and changes in your financial goals.

2. Exposure to market downturns

As your portfolio is crafted to move according to the market indices, it also makes it vulnerable to risk factors that affect the broader market. Market downturns can have a devastating impact on passive portfolios with investors having the option to either cut their losses or wait for recovery.

3. Tracking error

As individual stocks are not tracked, the market index tracking can have small errors or discrepancies leading to variances in the portfolio value. While the difference is small, it can stack up in the long run.

Types of passive portfolio management

There are three popular methodologies that can be used to craft passive portfolios. Let us examine them one by one.

1. Market-cap weighted portfolios

This approach focuses more on big companies, with the assumption that they are more stable than smaller enterprises. Thus, these portfolios assign more weight to the companies with a large market capitalisation. However, it does run the risk of over-concentration and a big company underperforming could potentially incur significant losses.

2. Equal-weighted portfolios

Think of this approach as the counterargument to the market-cap weighted portfolios. This methodology assigns equal weightage to all the stocks in a portfolio, regardless of the respective market capitalisation. It promotes portfolio diversification but also increases the risk of investments in more volatile companies.

3. Factor-based portfolios

Factor-based portfolios are designed to outperform the market in the long run. This approach promotes making investment decisions based on specific factors like value, quality, and momentum to pick stocks that exhibit these traits.

Key factors to consider for passive portfolio management

With the advantages and disadvantages and various passive portfolio management strategies, it is clear that careful consideration is required when trying to make the right investment choice. Here are some key factors to keep in mind:

1. Asset selection

Picking the right assets is fundamental in trading. The choice becomes even more important under passive portfolio management as the portfolio will largely remain the same over the long haul. Some important facets to remember in choosing assets are volatility, historical performance, and correlation with other stocks in the portfolio.

2. Asset allocation

Allocation refers to the mix of assets in your portfolio. Choose assets depending on your financial goals and risk appetite, and adjust the portfolio over time to align with your dynamic investment goals.

3. Rebalancing

This is an important part of passive portfolio management as tweaks in a passive portfolio are limited. Adjusting your portfolio to periodically align it with your dynamic goals and needs is important to maximise gains.

4. Monitoring performance

It is also crucial for investors to consistently check their passive portfolios to ensure their investment goals are met. This includes evaluating performance metrics like volatility and returns to make changes to the portfolio.


Passive portfolio management is a hands-off investment approach designed to mimic market indices, providing long-term growth, reduced risks, and lower costs. While it has notable advantages such as low fees, consistency, tax efficiency, and diversification, it also comes with limitations like reduced flexibility and vulnerability to market downturns. Understanding various strategies and key factors like asset selection, allocation, rebalancing, and performance monitoring is crucial for maximising the benefits of passive portfolio management.

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Frequently asked questions

What is the definition of the passive portfolio?
A passive portfolio strategy aims to achieve growth by creating a diversified portfolio similar to a market index instead of picking individual stocks. Its main objective is to match market returns instead of outperforming them. This strategy reduces trading costs and is less time-consuming, making it a popular choice for long-term investors.
What is an example of a passive portfolio?
A popular passive portfolio strategy is to invest in index funds that reflect a market index’s activity—for example, the S&P BSE 500. This is a good strategy to grow your wealth in the long run and manage your trading activity to maximise returns.
What are the types of passive portfolio management?

The three main types of passive portfolio management strategies include investing in index funds, direct equity, and exchange-traded funds (ETFs). Due to a simpler buy-and-hold approach, passive investing strategies are popular among investors looking for long-term capital gains.

What are the benefits of passive portfolio management?

Passive portfolio management requires lower fees and expenses, leading to higher returns. It also results in reduced portfolio turnover, reduced transaction costs, and reduced taxes. By tracking market indices or asset classes, it also minimises the risk of underperforming the market, making it an attractive portfolio management strategy.

How to construct a passive portfolio?

A passive portfolio can be designed by utilising pooled investments like exchange-traded funds (ETFs) and mutual funds. Alternatively, you can individually pick stocks and obtain exposure by using derivatives.

Which is better active or passive portfolio management?<br><br>

The answer lies in understanding your goals and evaluating market conditions. For example, active portfolio management is typically well-suited for volatile markets, as investors can make swift decisions regarding entry and exit. On the other hand, passive management will be better suited to conditions with neutral market sentiments and uniform equity valuations.

What is the difference between active and passive portfolio revision strategy?<br><br>

In the active revision strategy, you frequently update your portfolio to maximise returns and minimise risks, through regular buying and selling of securities. Conversely, in a passive revision strategy, there are rarely any changes to the portfolio. Investors here adhere to predefined formula plans, with modifications made only according to these rules.

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The information contained in this article is for general informational purposes only and does not constitute any financial advice. The content herein has been prepared by BFL on the basis of publicly available information, internal sources and other third-party sources believed to be reliable. However, BFL cannot guarantee the accuracy of such information, assure its completeness, or warrant such information will not be changed. 

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