By Deepak Pande, CFPCM
developed countries, Mutual Fund (MF) Assets under Management (AUM) has raced
past bank deposits. The scenario in India is quite different where MF AUM is slightly
above one-fifth of the bank deposits. Investing could be in the form of Active investment where a Fund Manager
actively manages the portfolio of a MF Scheme or Portfolio Management Scheme
(PMS). Other form of investments is Passive
investment where services of Fund Manager are required just for re-balancing
the portfolio in the same composition as that of a market index, which is
dynamic in nature.
passive investing viz. index funds, ETFs, FoFs, etc. in
India constitutes just around 9% amounting to Rs 2.72 lakh crore of the average
MF AUM of Rs 32.17 lakh crore as on 31st March 2021, yet it has witnessed annualised
growth of 142% in last 2 years.
investing is made up of funds tracking market indices where human intervention
is hardly required. In the United States, it has now reached nearly half-way
mark of the stock market capitalisation as more & more investors shun
stock-pickers and move towards index funds. Market share for passively managed
equity and debt funds has risen to almost 50%, up 400 basis points from June
2018, according to data released by Bank of America Merrill Lynch. That follows
a trend over the past decade in which investors have taken keen interest in
indexing, particularly through exchange-traded funds (ETFs).
10 years back, active investment had a nearly 3 to 1 ratio over passive
investment in U.S. equity funds, according to Morningstar. That gap began to
dwindle significantly in 2012 and has come down sharply when one looks at
Micheal Burry, the man who predicted/anticipated global financial crisis says,
the next stock market crisis is likely to be due to passive investment vehicles
like Index ETFs. The liquidity is propping up all stocks irrespective of their
fundamentals and earnings growth. He has compared growing stock and bond prices did with collateralised debt obligations did for subprime mortgages more than 12
years ago. Like most bubbles, the longer it goes on, the worse the crash will
be. In nutshell, incessant funds inflow in passive funds have swelled the index
so much that they are far ahead of their fundamentals in years.
In India, passive funds just mimic the portfolio allocation of the benchmark index, and Fund manager must keep rebalancing the portfolio.
India, passive funds just mimic the portfolio allocation of the benchmark
index, and Fund manager must keep rebalancing the portfolio, so as to keep it
aligned to the benchmark index. Since there are no skills required in managing
such passive funds, no stock-investment calls are required to be taken, thereby
reducing the cost for investors that, in turn, enhances the return for the
market scenario, where majority of actively managed funds are finding it
difficult to beat their respective benchmarks (barring last 5 months when
incessant FPI funds inflows have changed the active investment scenario),
investors are flocking to the passively managed funds and we see Fund Houses
launching more of passively managed funds. This shift of investors could be
attributed to SEBI re-classification of large cap, midcap and small cap
categories, linking Total Expense Ratio (TER) to the corpus of the MF scheme,
Indian equity markets maturing and enhanced coverage of equities.
than passively managed Index funds, Exchange Traded Funds (ETFs) are also
passively managed funds with low expense ratios. Since ETFs are traded on the
Stock Exchanges, the unit price keeps changing like an equity share throughout
the trading session, albeit, with a lower volatility.
of the index funds change only at the end of the day. The only distinction is
mandatory requirement of demat account for ETF unlike index fund where it is
optional. ETFs could have a problem of liquidity, as trading depends on the
demand and supply whereas MF units could be bought back by the Fund Houses when
redeemed, thereby posing no problem as far as liquidity is concerned.
of India (GoI) commenced encouraging investments in ETFs by launching first equity
CPSE ETF in March 2014 whereby units were offered at a discount to retail
investors. The CPSE ETFs FFO series 1 to series 6 evoked good responses from
investors as subscription always exceeded the issue size. Subsequently, GoI
launched first debt Bharat ETF in December 2019 followed by second tranche in
July 2020. The Bharat Bond ETF does not carry much credit risk as it invests
only in AAA-rated state-owned corporations.
investing in ETFs through a Systematic Investment Plan (SIP), one must
pre-determine number of units, not amount, as units have to be purchased in
round figure like equity shares. This facility of systematic investment in ETFs
is available on select online trading platforms. Investing in passive funds
makes sense in today’s scenario when majority of actively managed funds are not
beating benchmark indices, therefore dis-incentivising payment of a higher fee
for an actively managed fund. Hence, there is a need to increase the weight of
passive funds in one’s portfolio in Indian markets.
inclination towards passive investing through index funds and exchange-traded
funds (ETFs) has witnessed substantial growth over the years, substituting
higher cost active investment trend. A migration towards passive investment
could affect securities market in two major ways.
passive investing could establish higher correlation with returns and lesser
stock-specific price information. Secondly, it could impact total investment
inflows and alter market price dynamics. Since actively managed funds are
finding it increasingly difficult to beat benchmark indices, there has been
consistent outflows in the recent past, whereas passive funds’ corpus has remained
globe, passive funds have increased their allocation to US equities, Japanese
Government Pension fund's enhanced allocation towards equities, aptly supported
by the Central bank's ETF purchases. Similar trend has been witnessed in the
rising proportion of passive funds in European as well as emerging markets.
investors' choice of investment vehicle depends not only on the track record of
the fund manager but also on their own investment style preferences coupled
with risk appetite. In principle, investors could earn better returns by
identifying the active funds which are outperforming indices.
vs PASSIVE INVESTING
of active investing term passive investing as limited, with hardly any
flexibility, which keeps the investors to latch on to those holdings
irrespective of what is happening to the financial markets.
The recent shift of low-cost passive funds has been supported by artificial intelligence in the financial advisory industry.
definition, passive funds would never beat the benchmark, even during
tumultuous times when their core holdings are locked in to track the benchmark
index. Active funds could get you higher rewards but those come with higher
The recent shift of low-cost passive funds has been supported by artificial
intelligence in the financial advisory industry. These include, emergence of
robo advisors, fiduciary duty requirements, and moving away from upfront
incentives. Regulators have focused on bringing transparency for the investors
irrespective of active or passive form of investing.
There has been a rapid
growth trend, albeit on lower AUM base, over the past decade of ‘Passive
Investing’ in India. The primary factor attributed to more than quadruple rise
in passive investing is the inability of active Fund Managers to beat bench-mark
indices in the last couple of years.
November 2020 onwards,
we have witnessed massive inflow of FPI funds in equity markets where we
noticed some of the MF schemes managing to beat bench-mark indices, however,
majority of MF schemes lagged the bench-mark indices. Government of India has
aided in promotion of CPSE equity and Bharat bond ETFs by offering NAV discount
to the retail category of investors (Maximum of Rs 2 lakh investment). Besides
Index funds, those are managed passively having low expense ratio, Exchange
Traded Funds (ETFs) also fall under the same category with a lower expense
ratio. MF scheme NAVs are not dynamic in nature. This is because investments can
be done only at the day-end NAV. However, ETFs are traded on the Stock
Exchanges, and the ETF unit price keeps changing like an equity share
throughout the trading session, albeit, with a lower volatility as it consists
of basket of securities.
Apart from its
benefits, Passive Investing also brings in its own set of challenges as they
are purely driven by market forces, where there is no chance of outperformance,
unlike active MF schemes where Fund Manager could take a decision on entering
or exiting a stock. Another challenge in passive investing is that the the investors lack choice as index composition is static in nature.
Deepak is a CFPCM professional and a banking, finance and investment
professional. He is also the co-founder of Sky High Advisory LLP.