Why passive investing is growing in India?

[vc_row type=”in_container” full_screen_row_position=”middle” column_margin=”default” column_direction=”default” column_direction_tablet=”default” column_direction_phone=”default” scene_position=”center” text_color=”dark” text_align=”left” row_border_radius=”none” row_border_radius_applies=”bg” overflow=”visible” overlay_strength=”0.3″ gradient_direction=”left_to_right” shape_divider_position=”bottom” bg_image_animation=”none”][vc_column column_padding=”no-extra-padding” column_padding_tablet=”inherit” column_padding_phone=”inherit” column_padding_position=”all” column_element_spacing=”default” background_color_opacity=”1″ background_hover_color_opacity=”1″ column_shadow=”none” column_border_radius=”none” column_link_target=”_self” column_position=”default” gradient_direction=”left_to_right” overlay_strength=”0.3″ width=”1/1″ tablet_width_inherit=”default” tablet_text_alignment=”default” phone_text_alignment=”default” animation_type=”default” bg_image_animation=”none” border_type=”simple” column_border_width=”none” column_border_style=”solid”][vc_column_text css=”.vc_custom_1680092548232{margin-right: 16px !important;margin-left: 16px !important;border-right-width: 10px !important;border-left-width: 10px !important;}”]First, let us understand the difference between active and passive investing. Active investing involves investing in direct equity (stocks), equity mutual funds or other market-linked instruments with the objective of generating higher than the benchmark returns. The benchmarks can be the Nifty 50 index or the Nifty 200, depending on the investment. For e.g. a mid-cap equity mutual fund will be benchmarked against the Nifty Midcap index.

Passive investment is a strategy that focuses on replicating the index performance and generating returns equivalent to the index. ‘Index investing’ is a common passive investing strategy in which investors buy a representative benchmark and hold it for an extended time period. Exchange Traded Funds (ETF) as a tool, align perfectly with the ideology of passive investment.

Less expensive and match the returns of an index

One of the major advantages of passive investing is the low management fees or expense ratio. While an active fund requires a fund manager and a team of analysts who analyse and make buy and sell decisions, the job of a passive fund manager is much easier as he or she only needs to replicate the index in their fund.

Passive investment products simply track their underlying index for their performance i.e., they try to match it to the closest level. This tracking is subject to certain errors known as tracking errors. It is the fund manager’s job to reduce such errors to a minimum possible extent and thereby increase the returns. The investment can be made through the fund house or by the investors themselves as per the fund guidelines.

India sees a rapid rise in passive investing 

Globally over the past five years, more than 80% of the active funds have underperformed their benchmarks. That, along with higher costs, has pushed the investors towards low-cost passive opportunities like Exchange Traded Funds (ETFs).

Even in India, if we just look at the growth of passive investment from a pure numerical perspective, it indicates towards a rapid growth picture. Over the last five years, the passive assets under management (AUM) has witnessed a CAGR growth of over 55%. 

In March 2017, the passive AUM in India stood at Rs 52,368 crore, which stood at Rs 4,99,319 crore in March 2022 – a staggering growth of 57% CAGR.

Moreover, in the last year passive assets have almost doubled. Currently passive assets are about 13% of the overall assets in India, that number is expected to be nearly 40% in the next 5 years.

Reasons behind the growth

One of the primary reasons for growth in passive investing is that many investors along their investment journey have realised the need to diversify their holding into both alpha generating active investments and passive investments which will have lower risk but deliver returns equal to the benchmark. These are also cheaper than passive funds.

The other reason is the rise of investors through the pandemic period. During the pandemic, the number of demat accounts in the country doubled with the entry of many new investors. As life got back to normal, many of these new investors opted for passive investments either due to burning their fingers on bad investments or due to lack of time as the pandemic ended and life went back to usual routine.

Another factor helping the growth of passive investments is the regulator, SEBI revising norms for passive investments. SEBI had introduced revised norms for passive funds in May, 2022, which allow the creation of a passive ELSS. The minimum subscription requirement for NFOs was also reduced for ETFs and index funds. Sebi also allowed re-balancing in passive funds and stipulated the maximum range of tracking errors that passive funds can work within. This also led to many AMCs to introduce new passive schemes and the options for passive investment has become much wider than a few limited ETFs a year ago.

Which brings us to the debate whether active or passive investing is a better option for investors. In my view, this can’t be compared apple to apple as the rules governing each are different. At the same time, it is advisable to allocate a portion of your investments to passive investments as these balance out the non-performance of active funds at times, and lower the overall portfolio risk.

 

ABOUT THE AUTHOR

Ketan Sonalkar (SEBI Rgn No INA000011255 )

Ketan Sonalkar is a certified SEBI registered investment advisor and head of research at Univest. He is one of the finest financial trainers, with a track record of having trained more than 2000 people in offline and online models. He serves as a consultant advisor to leading fintech and financial data firms. He has over 15 years of working experience in the finance field. He runs Advisory Services for Direct Equities and Personal Finance Transformation.

Note – This channel is for educational and training purpose only & any stock mentioned here should not be taken as a tip/recommendation/advice

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