Passive investing has gained steady growth globally in the last few years. In the US, Passive Funds have surpassed Active Funds in terms of ownership of US stocks. As per media reports, in the US, more than $2 trillion has flowed from active funds to passive funds in the last decade, mainly Exchange-traded Funds (ETFs).
In India too, Passive investing has caught the attention of investors and fund managers alike, even as Active funds continue to dominate. The AUM of Passive Funds (Index Funds, ETFs, and Fund of Funds investing overseas) has more than doubled from Rs 2 trillion as of June 2020 to Rs 5.2 trillion as of June 2022. Likewise, the number of folios has jumped from 3.8 million to 20 million, while the count of schemes has risen from 151 to 275 during this period.
Benefits of Passive investing:
- Lower cost compared to Active funds
- Broad diversification at minimal investment amount
- Ease and convenience of scheme selection
- No worry over star fund manager exiting the scheme
- And more importantly, no fear of underperforming the markets
Does it make sense to invest in Passive Funds now?
After a sharp bull rally between 2020 and 2021, the equity market has corrected sharply from its peak recorded in October 2021. Factors such as spiralling inflation, geopolitical tensions, rate hikes by global central banks, and concerns about the likelihood of a recession have led to a massive selloff, particularly by foreign investors who have shifted focus towards safe havens and have clouded the outlook for the equity market.
In the current market scenario where the equity markets are witnessing sharp swings due to global uncertainties, Passive investing can be a suitable bet for investors who are just beginning their investment journey. It is also suitable for cautious investors who do not have the appetite for high market volatility and are looking to earn returns in line with the market.
Notably, the Passive fund segment has broadened in India over the last couple of years, with mutual funds launching products to cater to the needs of different types of individuals. Thus, it is now possible to create a low-cost, low-maintenance, and diversified portfolio of mutual funds consisting of passive funds. Earlier, investors had limited options in choosing passive funds that track Nifty 50, S&P BSE Sensex, and a few other sector-oriented schemes such as Banking index funds. But over time, many more index options have been added to the list of passive funds for investors to choose from.
Here are the different types of passive funds available for investment in India:
1) Passive Equity Funds
For your long-term goals, you can consider investing in passive equity funds (through Index funds, ETFs, or Fund of Fund schemes) that track various market cap segments such as Nifty 50, Nifty Next 50, Nifty Midcap 150, Nifty Smallcap 250, etc. Passive equity funds offer you the opportunity to benefit from the growth potential of equities but at a lower cost compared to actively managed equity mutual funds.
Sector/theme-oriented passive funds that track various sectors/themes such as Banking, Pharma, Consumption, etc., are also available. However, investors should ideally avoid investing a larger allocation in these as they carry high concentration risk. .
2) Passive Debt Funds
Debt ETFs/Index funds are passively managed mutual funds that invest predominantly in fixed-income instruments such as corporate bonds and government bonds. These schemes invest in the same proportion as the underlying index, such as the Nifty 1D Rate index, Nifty Bharat Bond Index, Nifty 5-year G-sec Index, Nifty CPSE Bond Plus SDL Index, etc. Passive Debt Funds are suitable for short to medium-term goals of investors. While selecting passive debt funds for your portfolio, ensure that the maturity profile of the scheme aligns with your investment horizon and risk appetite.
3) Passive Gold Funds
Finally, you can also diversify your portfolio using efficient financial forms such as Gold ETFs and Gold Funds that can form a part of your long-term portfolio. These funds track the domestic prices of gold and thus, the returns will depend on the movement of gold prices. The benefit of investing Gold through passive funds over physical form is that you are assured of high purity. Furthermore, since the units are held in digital form, you need not have to worry about theft and storage hassles.
How much weightage should you allocate for different indices?
The weightage in each of these indices will depend on your financial goals, risk appetite, and investment horizon before the goal befalls. For instance, if you have a high-risk appetite and an investment horizon of at least 5-7 years, your portfolio can be biased towards passively managed equity schemes. Adopt a sector-agnostic portfolio allocation approach to invest across large-cap, mid-cap and small-cap-oriented passive schemes.
However, avoid mid-cap and small-cap-oriented passive schemes if your investment horizon is less than 5-7 years.
Conservative investors should stick mainly to debt-oriented passive schemes of suitable time horizon, along with some portion in Gold schemes for diversification purposes.
Final words…
Passive investing drastically reduces risks associated with the wrong selection of stocks/sectors in a portfolio (at the mutual fund level) and the wrong selection of a mutual fund scheme (at the investor’s level). However, this does not mean that passive funds are free from risks related to equity, debt, and gold investment. This makes it important to select schemes that are suitable for your financial needs and as per your risk appetite.
Lastly, when you invest in passively managed funds, prefer the one with low tracking error so that the performance of the fund does not deviate much from the index.
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