The simplicity of Passive Investing
Over the years, active funds are finding it increasingly difficult to beat their respective benchmarks. Hence, these days, more and more people prefer to invest in passive funds through index funds and Exchange Traded Funds (ETFs). This article will discuss the simplicity of passive investing, its benefits, and the performance of some passive funds.
What is passive investing?
Passive investing is the process of buying security (may include equity shares, gold, debt, etc.) or a basket of securities and holding them for a long time. There is minimal buying and selling, and hence the cost of passive investing is lower. A passive investor doesn’t aim to profit from the price fluctuations of the security. As passive investing is a buy-and-hold strategy, it removes the element of market timing. The aim of passive investing is to earn market returns and not to outperform them.
An index fund invests in a basket of securities that are a part of a benchmark index. It invests in all the index constituents in the proportion of their weightage in the index. An index fund mirrors or replicates the performance of the benchmark index.
Various indices are offered by the NSE and BSE, based on which mutual funds offer various index schemes. Some of the indices offered by the NSE include the Nifty 50, Nifty Next 50, Nifty 100, Nifty Midcap 150, Nifty Smallcap 250, Nifty 500, etc. The NSE also offers various sectoral and thematic indices.
Mutual fund houses offer various index funds based on the above indices. Following are some of them.
|Index Mutual Fund Scheme Name||Benchmark|
|UTI Nifty Index Fund||Nifty 50|
|HDFC Index Fund – Nifty 50||Nifty 50|
|ICICI Prudential Nifty Index Fund||Nifty 50|
|ICICI Prudential Nifty Next 50 Index Fund||Nifty Next 50|
|UTI Nifty Next 50 Index Fund||Nifty Next 50|
|Axis Nifty 100 Index Fund||Nifty 100|
|Motilal Oswal Nifty Midcap 150 Index Fund||Nifty Midcap 150|
|Nippon India Nifty Midcap 150 Index Fund||Nifty Midcap 150|
|Motilal Oswal Nifty Smallcap 250 Index Fund||Nifty Smallcap 250|
|Nippon India Nifty Smallcap 250 Index Fund||Nifty Smallcap 250|
|Motilal Oswal Nifty 500 Fund||Nifty 500|
|Motilal Oswal Nifty Bank Index Fund||Nifty Bank|
Exchange Traded Fund (ETF)
An ETF, just like an index fund, invests in a basket of securities that are a part of a benchmark index. An ETF also mirrors or replicates the performance of the benchmark index.
However, there are some fundamental differences between an index mutual fund scheme and an ETF. The buying and selling of index fund scheme units are done through the AMC. The buying and selling of ETF units are done through the stock exchange. You need a demat account for buying and selling ETFs. As ETFs are traded on the stock exchange, the price discovery of ETFs happens on a real-time basis. However, one of the disadvantages of an ETF is that the systematic investment plan (SIP) is unavailable. With index mutual fund schemes, you can do a SIP.
Mutual fund houses offer various ETFs based on various indices. These can be broad indices or sectoral or thematic indices. Following are some of them.
|SBI ETF Nifty 50||Nifty 50|
|UTI Nifty 50 ETF||Nifty 50|
|Nippon India ETF Junior BeES||Nifty Next 50|
|SBI ETF Nifty Next 50||Nifty Next 50|
|Nippon India ETF Nifty Midcap 150||Nifty Midcap 150|
|Nippon India ETF Bank BeES||Nifty Bank|
|CPSE ETF||Nifty CPSE|
|Mirae Asset ESG Sector Leaders ETF||Nifty 100 ESG Sector Leaders|
|ICICI Prudential IT ETF||Nifty IT|
|Nippon India ETF Consumption||Nifty India Consumption|
|Motilal Oswal 5-Year G-Sec ETF||Nifty 5-year Benchmark G-Sec Index|
|Axis Healthcare ETF||Nifty Healthcare|
|Nippon India ETF Shariah BeES||Nifty 50 Shariah|
Benefits of passive investing
As passive investing is a buy-and-hold strategy, it has many benefits. Some of these include:
Low cost: The biggest benefit of passive investing is the low cost. Passive investing involves a buy-and-hold strategy. As there is minimum selling, the transaction costs are low. The fund manager doesn’t need to spend any time and money doing research to identify which stocks to invest in. The fund manager has to invest in all fund constituents as per their weightage and hold them. Due to all these factors, the expense ratio of passive funds is lower than that of active funds.
Diversification: When you invest in a passive fund with a benchmark such as Nifty 50, you automatically get diversification. The Nifty 50 represents a basket of 50 stocks belonging to more than 20 different sectors. Similarly, passive funds with benchmarks such as the Nifty 100 Index or the Nifty 150 Midcap Index provide diversification to the investor.
Low risk: An index fund mirrors or replicates the index returns. There is no pressure on the fund manager to beat the index and generate returns higher than the index. Hence, there is no need for the fund manager to take any additional risks apart from market risk.
- Removal of human bias: In an active fund, the fund manager decides which stocks to buy, how much to buy, and when to buy. All these decisions are subject to human bias as the fund manager takes these decisions. Sometimes these decisions can impact the fund returns adversely. But, in a passive fund, the fund manager has to buy all the index constituents as per their weightage. Hence, passive funds are free of human bias.
Rise of index funds in India
Over the last few years, the popularity of index funds has grown in India. As of 31st March 2017, the AUM of index funds was only Rs. 2,452 crores. But, in six years, as of 30th June 2021, the AUM of index funds in India has grown 10-fold to Rs. 24,920 crores.
Note: The amount shown is in Rs. crores.
Like index funds, over the last few years, the popularity of ETFs has grown in India. As of March 2017, the AUM of ETFs was Rs. 50,211 crores. But, in six years, as of June 2021, the AUM of ETFs has grown more than six-fold to Rs. 3,22,523 crores.
Note: The amount shown is in Rs. crores.
Factors to consider while investing in passive funds
When choosing a passive fund for investment, you should consider three important factors:
- Expense ratio: When you decide to invest in an index fund with, say, the Nifty 50 as a benchmark, from among various index funds tracking the Nifty 50 Index, you should choose the fund with the lowest expense ratio. The lower the expense ratio of an index fund, the better.
- Tracking error: When you decide to invest in an index fund with the say, Nifty 100 as a benchmark, from among various index funds tracking the Nifty 100 Index, you should choose the fund with the lowest tracking error. The lower the tracking error of an index, the better.
- Assets under management (AUM): When you decide to invest in an index fund with the say, Nifty Midcap 150 as a benchmark, from among various index funds tracking the Nifty 150 Midcap Index, you should ideally choose the fund with the highest AUM. If you come across a fund with the combination of lowest expense ratio and lowest tracking error, then you can choose that fund even if it doesn’t have the highest AUM.
Performance of index funds
In the above section, we have seen the benefits of passive investing and the factors to consider for choosing an index fund. Now, let us see the returns given by some index funds over different periods.
Note: The above returns are as of 2nd August 2021. The index funds have been ranked based on returns given over a 5-year period. The one-year returns are absolute. The three-year and five-year returns are CAGR.
Index funds should be a part of your portfolio based on asset allocation. To plan and systematically invest in index funds to achieve your financial goals, you can partner with the Glide Invest App. You will get guidance for:
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