Passive investing is fast catching up in India. 2020 was said to have marked the dawn of passive investing era in India with slew of ETF and index fund launches and significant growth in AUM.
The rise in interest, however, has not led to more diverse offerings. Passive investing space remains heavily dominated by large-cap focused funds. Data available on AMFI shows that 72% of equity passive funds invest pre-dominantly in large-cap stocks.
There are only a handful of options when it comes to small-cap and mid-cap focused ETFs and index funds.
In case of flexi-cap funds, the second largest fund category in active space, there’s none except for a fund of funds — Nippon India Passive Flexicap FoF.
The lack of options is a result of two broad factors. One, the passive investing market is still in a nascent stage in India. Second, the rising demand for large-cap passive funds as active funds struggle to generate alpha. "We are at an inflection stage. When you look at the possibility of an active manager giving a passive product, the first product will be where alpha is diminishing, which is large-caps," said Swarup Mohanty, CEO of Mirae Asset MF.
The issues can also be divided into three subheads – low penetration, liquidity concerns and scope for generating alpha in mid- and small-cap space.
Low penetration
The penetration of mutual funds, which is already low in India, decreases further in case of passive funds.
Take ETFs for example. According to the April sales figures released by CAMS, only 6% or Rs 184 crore of the gross ETF inflows (Rs 3,136 crore) came from B30 regions. These figures, however, are not representative of the complete industry. The data is only from CAMS serviced MFs. But it does gives us the fair idea of the penetration of ETFs.
The overall passive market scenario has led to mutual funds and investors sticking to comparatively low risk large-caps.
Liquidity concerns
Industry faces liquidity concerns beyond the large-cap space, especially in case of mid and small caps.
A senior MF executive, who did not wish to be named, said the illiquidity makes it difficult to execute midcap and smallcap ETF strategies. "If there is a redemption in a smallcap ETF and the manager is unable to sell the underlying securities, the fund will start showing tracking error," the executive said.
Scope for generating alpha
The popularity of passive funds in India has mostly to do with one narrative. i.e., most active large-cap funds fail to beat benchmark returns. But the problem is there is no such problem with active mid-cap, multi-cap and even flexi-cap funds. These active funds have done better than their benchmarks more often than not.
This scenario leaves the industry with no proper sales pitch for these funds.
"Passive investing usually works better with large cap stocks. The basic differentiation that comes with small and midcap stocks is the stock picking ability of the fund manager. Actively managed fund work better with these categories," said MFD Hemant Rastogi.
‘Demand will come, so will the offerings’
Vikas Sachdeva, CEO of EMKAY Investment Managers, said the products will eventually come. First the demand has to be generated. “When demand happens, more ETFs will come. Currently, there’s no demand for mid and small-cap passive funds as actively managed funds have outperformed,” he said.
Rahul Jain, Senior VP Research at International Money Matters, echoed similar views. “In case of large caps, there is limited scope for a fund manager to create alpha. In case of mid and small caps, fund houses believe that their opportunities for fund managers to do better,” he said.
“As and when the differential comes down, you will see more and more fund houses launching passive funds beyond the large caps. There were many AMCs who didn’t even have Nifty50 funds until some time back. First step was large-caps, mid-caps will come next and then the small-caps,” he added.
