Passive funds infinite possibilities – Current scenario in India and abroad
Many active funds are underperforming the benchmark
Over the last few years, the annual SPIVA India Scorecard, published by S&P Global, has shown how many active funds have underperformed their respective benchmarks. The last report was published based on data as of 31st December 2021. The report highlighted that in the large-cap category, 50% of the funds underperformed the benchmark in the last one year, 70% underperformed in the last three years, and 82% underperformed in the last five years.
The performance of active funds in the mid and small-cap categories is somewhat better. The under performance of many active funds has led many investors to shift to passive funds. As a result, the AUM of passive funds has risen significantly in the last few years. This article will explore passive funds, investment options, and their share in India and globally.
What is a passive fund?
A passive fund invests its money in the constituents of an index (benchmark) as per their weightage in the index. It mirrors or replicates the performance of the benchmark. The returns of a passive fund are usually slightly lower than the benchmark index due to scheme expenses and cash levels. Passive funds are of two types – Exchange Traded Funds (ETFs) and index funds.
For example, a Nifty 50 Index Fund has the Nifty 50 Index as its benchmark. The fund will invest its money in all 50 constituents of the Nifty 50 Index as per their weightage in the Nifty 50 Index. The fund will mirror the performance of the Nifty 50 Index and replicate its returns.
What are the benefits of investing in passive funds?
Some of the benefits of investing in passive funds include:
1. Low costs
One of the biggest benefits of investing in a passive fund is the low cost compared to an active fund. There is no research involved for stock selection in a passive fund. There is no frequent buying and selling of securities. As a result, the fund management charges are low, resulting in a lower expense ratio than an active fund. The low expense ratio is passed on to investors.
Passive funds invest in all the constituents of a broader index, such as the Nifty 50, Nifty Next 50, Nifty Midcap 150, Nifty Smallcap 250, etc. These are all diversified indices representing almost all or most of the sectors of the economy. Hence, by investing in these funds, the investor automatically gets the benefit of portfolio diversification which is essential.
3. Removal of fund manager bias
In an active fund, the fund manager takes all selling & buying decisions. The fund manager decides which stocks to buy, when, how much, and at what price. Similarly, the fund manager decides which stocks to sell, when, how much, and at what price. So, an active fund’s buy and sell decisions are subject to fund manager bias, although all these decisions are backed up by research.
But, in a passive fund, there is no such fund manager bias. In a passive fund, the fund manager has no say in buy and sell decisions. Whenever the benchmark index reconstitution happens, the fund manager has to buy the shares of the company included in the index and sell the shares of the company excluded from the index.
Passive funds are managed in a transparent manner. The scheme money is invested in all the index constituents as per their weightage. The portfolio is shared with the unit holders regularly.
Types of index funds available for investment
As the popularity of index funds is rising, we are seeing AMCs introducing new types of index funds. Initially, we had equity index funds based on market capitalization. Now, we have smart beta index funds and debt index funds.
Market capitalization index funds
These index funds are based on an index which itself is based on market capitalization. Some examples of these include:
- Nifty 50 Index Fund based on the Nifty 50 Index
- Nifty Next 50 Index Fund based on the Nifty Next 50 Index
- Nifty 100 Index Fund based on the Nifty 100 Index
- Nifty 150 Midcap Index Fund based on the Nifty 150 Midcap Index
- Nifty 250 Smallcap Index Fund based on the Nifty 250 Smallcap Index
- Nifty 500 Index Fund based on the Nifty 500 Index
Smart beta index funds
Smart beta index funds are based on certain factors considered for the benchmark index's constitution. These factors include momentum, value, quality, low volatility, etc. Some benchmark indices are constituted using a combination of these factors.
Some of the indices based on the above factors include:
- Nifty 200 Momentum 30 Index
- Nifty 50 Value 20 Index
- Nifty 100 Quality 30 Index
- Nifty 100 Low Volatility 30 Index
Some AMCs have launched smart beta index funds based on the above factor-based indices.
Debt index funds
In the debt category, there are many indices which the NSE has launched. Some AMCs have launched some ETFs on some of these indices. There is one index fund in the debt index fund category – Edelweiss NIFTY PSU Bond Plus SDL Apr - 2026 50:50 Index Fund.
India's passive mutual funds industry has seen good growth in the last few years. Here are some passive funds industry statistics as of June 2022.
|Assets under Management (AUM)||Rs. 5.01 lakh crores (12% year-to-date growth)|
|Number of products||229 (up from 184 products)|
|Size of the industry||14% share of the overall mutual fund industry|
From December 2020 to December 2021, the industry AUM saw a growth of 57% from Rs. 2.85 lakhs and 137 products. The overall share of the passive mutual funds industry grew from 9% (December 2020) to 12% (December 2021) and further to 14% (June 2022).
Global passive funds industry
The passive fund industry in India has seen high growth in the last few years. But, the global passive fund industry, specifically in the US, has seen good growth for quite a few years. Here are some global passive funds industry statistics.
|Assets under Management (AUM)||USD 8.8 trillion|
|Number of products||More than 10,000|
Huge scope for growth for the passive fund industry in India
In some countries, the share of passive and active funds is around 50:50, while in some countries, the share of passive funds has gone beyond active funds. However, in India, the passive fund industry share is only around 15% of the overall mutual fund industry. So, there is tremendous scope for the passive fund industry to increase its market share in India. Along with the growth in market capitalisation index funds, there is scope for innovation in factor-based and debt index funds. SEBI has paved the way for the launch of ELSS index funds. Soon we may see an ELSS index fund.
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