Until a few years ago, actively managed equity funds were the default choice for Indian investors looking to invest in equity through mutual funds. But as a few actively managed funds have struggled to beat their benchmark, passive funds have started to attract investors interest.
Unlike active investing where investors give their money to a fund manager to use his skills, knowledge and experience to pick stocks; In passive investing, the investment strategy is to replicate the returns of the index. Therefore, when the fund manager in passive funds gets the money from an investor, he buys the stocks in the same proportion as the index. Examples of investment products that follow such an investment strategy are exchange traded funds (ETFs) and index funds.
Benefits
One of the major benefits of passive funds is they have lower expense ratios as compared to actively managed funds; this results in lower costs for the investors. The difference in expense ratios of active and passive funds could go as high as 1-1.5%, as the fund management charges and transaction costs are minimal in case of passive strategies.
Another major benefit is elimination of unsystematic risk, which is the risk of selection of wrong investment products. Since the passive investment strategy does not offer such flexibility to the fund managers, such risks get mitigated.
In other words, the idea of buying passive funds is to buy companies at all points of time. The index actually rebalances itself every three to six months. This means investors can be sure to always hold the best possible companies. In fact, such rebalancing ensures that passive funds are able to get the stocks that are doing well early on, while making sure that poor performing stocks get less significance.
Options
In the Indian MF industry, currently there are more than 110 passive funds ranging from equity to debt to commodities like gold.
In equities, there are passive funds that replicate the large cap, mid cap and small cap space. There are also passive strategies that follow the top 500 stocks in Sensex. Further, if investors want to take a call on sectors, they can bet on sectors such as banks, infrastructure, consumption and so on. There are also products that offer stocks based on value.
Similarly, in case of debt products, investors can bet on the indices of 10-year G-sec, 8-13 year G-sec, PSU bonds etc. There are products to invest in gold indices and international indices as well.
Here are some of the benchmark indices based on which there are passive funds available in the industry.
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NIFTY Bank Total Return Index |
NIFTY PSU Bank Total Return Index |
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Domestic Price of Gold |
NIFTY 100 Total Return Index |
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NIFTY Next 50 Total Return Index |
NIFTY 8-13 yr G-Sec Index |
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S&P BSE Sensex Total Return Index |
NIFTY Midcap 100 Total Return Index |
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NIFTY 100 Total Return Index |
Nasdaq 100 Total Return Index |
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NIFTY 50 Total Return Index |
NIFTY Bank Total Return Index |
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S&P BSE Bharat 22 Total Return Index |
NIFTY Midcap 150 Total Return Index |
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NIFTY CPSE Total Return Index |
NIFTY Smallcap 250 Total Return Index |
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NIFTY 50 Equal Weight Total Return Index |
NIFTY India Consumption Total Return Index |
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NIFTY 1D Rate Total Return Index |
NIFTY Dividend Opportunities 50 Total Return Index |
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NIFTY 100 Quality 30 Total Return Index |
Hang Seng Total Return Index |
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S&P BSE Liquid Rate Total Return Index |
NIFTY Infrastructure Total Return Index |
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S&P BSE Midcap Select Total Return Index |
NIFTY 50 Value 20 Total Return Index |
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NIFTY 100 Low Volatility 30 Total Return Index |
NIFTY 10 yr Benchmark G-Sec Total Return Index |
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S&P BSE 500 Total Return Index |
NIFTY 200 Quality 30 Total Return Index |
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NIFTY 50 Value 20 Total Return Index |
NIFTY 50 Value 20 Total Return Index |
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Nifty Private Bank TRI |
NIFTY 200 Quality 30 Total Return Index |
You can see the complete product basket by clicking here. The overall AUM stands at Rs 2.40 lakh crore.
Selecting passive funds
Given the fact that multiple fund houses offer passive funds that track the same index, is there a case for prudent fund selection?
While picking passive funds, there are two major factors. One is the expense ratio. The whole idea about passive funds is to track the index as closely as possible. Try to find a fund with the lowest cost as this would mean lower money is being charged for the fund. And this will keep returns closer to the index.
The second important factor to look at is the tracking error. Ideally, the funds with lower tracking error tend to replicate the Index in a more accurate manner than the funds with high tracking error.
Investment method
Fund houses allow SIP in index funds which can help the investor in rupee cost averaging conveniently. There is also room for tactical play if an investor wants to park money at a certain percentage of fall in the indices.
Prudent advisors feel that it is not active vs passive in India at this point. Rather, it is a combination of active and passive funds. Experts feel that clients can invest 15-20% of their portfolio in passive funds to get the best out of both strategies.
Mutual Fund investments are subject to market risks, read all scheme related documents carefully.
