Passives are about selling reliability, cost effectiveness and transparency over excitement’

The share of passives in the total mutual fund assets has been increasing with each passing year. In such a scenario, it is important for MFDs to include passives in their client portfolio. However, many MFDs who are used to sell active funds find it difficult to pitch passives to their clients. In order to help such MFDs successfully market passives, Prem Khatri, Founder & CEO, Cafemutual shared with us tips at the recent Cafemutual Passives Conference. Here is what he said:

The scope of passives

• Passives are no longer limited to institutions and HNI now, they hold over 4.19 crore folios, about 20% of the total industry count
• Passives account for a higher share of assets than actives in developed markets like the USA. India is also likely to follow this trend which can be seen in the rise of popularity of passive investing in recent years

Selling passives is different

• Passives are about selling reliability, cost effectiveness and transparency over excitement. It therefore requires a different mindset and approach compared to the traditional way of selling active funds
• While MFDs position themselves as advisors to their clients who will help them choose the right fund which can outperform the market, for passives, the approach involves selling a guaranteed structure which will give market returns to the clients and will not underperform compared to the benchmark (except for tracking error)
• In passives, the job of an MFD is not fund selection but investor education and portfolio construction using asset allocation

Understanding investor mindsets

• There are three different types of investor mindset: skeptic, opportunist and pragmatist
• Skeptics are investors who have a firm belief that they will be able to select funds which can beat the market and think that passive funds are a lazy way to access the stock market
• MFDs should tell such clients that even the top fund managers fail to outperform the index consistently. A fund which is performing very well this year may not be the top performer next year
• Secondly, passives offer safety, consistency and low cost which is why even global institutions now prefer passives over actives
• The second type of investor is an opportunist who is looking for the next big thing and doesn’t want to be left out of an important trend which is why he is always looking to find out where the market is headed
• To such investors, MFDs should highlight that passives are a global trend today due to which smart investors are shifting towards passive funds after making sufficient gains in the active funds
• The third type of investors are pragmatists who are disciplined in their investment approach. To such investors, MFDs should pitch passives as consistent, cost effective and disciplined investment solutions that help them stay on track with the markets
• In general, MFDs should focus on financial goals of the client instead of returns as clients are more interested in fulfilling their financial goals than getting high returns
• They should also sell the power of low cost of passives which can lead to higher returns and make a significant difference in the long term due to the power of compounding. For example, the difference in final amount for a Rs. 10 lakh investment compounded at 12% CAGR and 12.5% CAGR over five years is Rs. 37,000. A study by Cafemutual of industry data shows that only 100 out of 293, about 34%, of active equity funds in India outperform their benchmark indices   

Countering investor objections with conviction

• While dealing with investor concerns, the first step for an MFD is to acknowledge the concerns of clients about passive investment like lower returns
• Secondly, MFDs should give the investors a new perspective by explaining that active funds can be volatile while passives can deliver consistent, low cost and reliable returns
• Next, MFDs can give evidence to prove this point like SPIVA reports published by S&P that show that over 5-10 years, 70-80% active funds underperform compared to the index
• MFDs can also position passives as a core investment strategy and add active funds on top of them to boost returns
• Finally, MFDs can close the pitch with a proposition to build wealth steadily and safely using passives
• MFDs can also use powerful lines like ‘Boring can be beautiful – especially in investing’, ‘Costs are certain, returns are uncertain. Let’s control what we can’, ‘Consistency beats chasing winners’ to help their clients understand the philosophy of passive investment

How to select passive funds?

• For index funds, MFDs should do a quantitative analysis of passive schemes and look at parameters like tracking error and tracking difference and select funds which perform better in these metrics.
• For ETFs, two more parameters need to be looked at: impact cost and trading volume which show the liquidity of a particular scheme.
• While choosing a smart beta strategy like momentum, value etc.  do research on which strategy suits different market cycles and choose whichever is appropriate for you.

In conclusion, MFDs should remember that they are not selling hope but a philosophy with passives. They should also understand that if you don’t sell passives to your clients, someone else will.

You can watch the complete session here.