Passive investing is not a very old phenomenon. The style of investing came into being in 1976 and emerged as the preferred option for US investors within a few decades. Passive funds are now on a roll in India and are expected to see more success in coming years.
The soul of passive funds lies in indices and hence the story of their emergence will be incomplete without discussing the advent of indices first.
Stock exchanges, which were officially functional since 1612, got their first index in July 1884. Called Dow Jones Transportation Index, the index was made up of 11 transportation stocks, including nine railway companies. The index got its name from its publisher Charles Dow.
With the success of Dow Jones Transportation Index, many indices were launched over the years but the idea of replicating them as an investment strategy didn't arrive for several decades.
The world was soon hit by the two World Wars and investments and stocks markets took a back seat in people's lives. When stability came back in 1950s, the stock markets, especially that of the US, saw a boom, bringing back the interest of investors and academicians alike. This was the period when several theories related to stock markets and mutual funds emerged.
In 1952, Harry Markowitz’s “Modern Portfolio Theory” introduced the idea of risk-adjusted returns. The Nobel Prize winning theory explained how risk-averse investors can construct portfolios to maximise returns.
In 1960s, Eugene Fama’s Efficient Market Hypothesis (EMH) came into the picture. The theory argued that earning excess returns or outperforming the market isn’t possible in the long-run.
And finally in 1972, Burton Malkiel published a book "A Random Walk Down Wall Street". This book proposed that historical prices have no predictive power.
These three theories are said to have birthed the idea of low-fee index funds.
During the same time, the concept of active funds came under criticism. Speaking in the US Congress in 1967, economist and Nobel laureate Paul Samuelson famously said that it was usually more profitable to invest in a mutual fund company rather than in their funds.
Samuelson was one of the first to advocate the idea of index funds. In an article during the same time, he had written that brokerages "should set up an in-house portfolio that tracks the S&P 500 – if only for the purpose of setting up a naive model against which their in-house gunslingers can measure their prowess."
The idea was finally picked up Jack Bogle in 1976 when he launched an S&P 500 index fund. Bogle launched the fund through The Vanguard Group which he had established in 1975.
The fund took time to gain acceptance but once it did, the mutual fund industry changed forever.
Advent of passive investing in India
Passive investing didn't take long to arrive in India. However, it started gaining traction only in the last few years.
IDBI Index INit’ 99 Fund, which was launched in 1999, was the first passive fund in India. UTI Nifty Index Fund came shortly after in March 2000.
Currently, a few fund houses like Nippon India Mutual Fund offer a host of products through passive funds.
