What is a Passive Fund?
A passive fund is a type of Index Fund or Exchange-Traded Fund (ETF) that aims to replicate the performance of a particular market index, such as the S&P BSE Sensex or the Nifty 50. Passive funds are designed to provide investors with exposure to a broad range of assets, such as stocks, bonds, or commodities, without the need for active management.
Unlike actively managed funds, which are managed by a team of investment professionals who make decisions about which assets to buy and sell, passive funds are designed to track the performance of the underlying index as closely as possible. This means that the fund’s portfolio will automatically adjust to reflect changes in the index, without the need for any intervention from the fund manager.
Passive funds offer several benefits to investors – they are easy to understand, effective for wealth creation, and are economical in the sense that they have lower expenses.
The start of Passive Funds in the US
Passive funds were first introduced in the United States in the 1970s. The concept of a passive fund was developed by Jack Bogle, the founder of the Vanguard Group, one of the largest investment management companies in the world.
Bogle recognized that actively managed funds, which were the dominant type of investment vehicle at the time, often struggled to outperform the market. He believed that this was due to the high fees charged by these funds, as well as the inherent difficulty of consistently beating the market. The first passive fund was launched by Vanguard in 1975, and was based on the S&P 500 index.
Since their introduction, passive funds have become increasingly popular in the United States, as more and more investors have come to recognize the benefits of these funds. Today, passive funds make up a significant portion of the investment landscape in the United States, and are widely used by both retail and institutional investors.
Growth of Passive Funds in India
Though India’s first passive funds were launched more than a decade ago, Gold ETFs accounted for a majority of the AUM till 2013. The launch of the CPSE ETF in Mar-2014 and the EPFO’s decision to start investing in ETFs based on Nifty 50 and S&P BSE Sensex Index starting Aug-2015 greatly helped with the acceptance of Equity passive funds. The launch of the 1st Bharat Bond ETF in Dec-2019 played a similar crucial role for Debt passive funds.
The total AUM of passive funds has grown from less than 10k crs in Dec-13 to more than 5.5 lakh crs as of Sep-22. Over the same period, the AUM share of passive funds has grown from less than 2% of industry AUM to more than 17%, indicating that passive funds are growing significantly faster than the overall industry.
Exhibit 1 – AUM growth of Passive Funds in India
Source/Disclaimer: AceMF, MOAMC Research. Data as of 30-Sep-22.
This strong traction has led to a lot of Mutual Fund houses launching passive schemes across various categories. Unsurprisingly, the number of passive schemes has more than doubled from just over 100 schemes in Sep-19 to more than 220 schemes in Sep-22.
These passive schemes can be broadly classified into 4 categories or asset classes – Domestic Equity, Debt, International Equity and Commodity (Gold & Silver for now). As is evident in the chart above, most of the AUM growth has come in the Domestic Equity category with the lion’s share going towards index funds and ETFs that track the Nifty 50 and S&P BSE Sensex Index. However, investors are increasingly showing great interest in the Debt and International categories as well. There has also been a recent pick-up in demand for sub-categories like Sector, Thematic, and Factor-based passive funds within Domestic Equity.
What’s driving this growth?
This impressive growth of passive funds in India is similar to what we have seen in the United States a couple of decades ago. Indian Investors are increasingly choosing passive funds because of the following reasons –
- Difficult for active managers to consistently beat the market
- Low expenses charged by passive funds
- Transparent investment process
- No discretionary investment decisions or fund manager bias
- Supportive regulatory initiatives such as reclassification of mutual funds, and benchmarking of performance against Total Return Indices
The road ahead for Passive Funds in India
Looking at the United States, passive funds account for more than 40% of overall mutual fund AUM, it is only a matter of time before passive assets overtake active in the United States. This can give an idea of where the Indian mutual fund industry may be headed and shows that there may still be ample room for growth of passive funds.
Overall, the growth of passive funds in India is a result of the increasing awareness and understanding of these funds among investors, as well as the expanding Indian stock market and supportive regulatory environment. Therefore, it may be a reasonable expectation that this trend may continue in the future.
Disclaimer: This article has been issued on the basis of internal data, publicly available information and other sources believed to be reliable. The information contained in this document is for general purposes only and not a complete disclosure of every material fact. The indices mentioned herein is for explaining the concept and shall not be construed as an investment advice to any party. The graph used above is to explain the concept and is for illustration purpose. The information / data herein alone is not sufficient and should not be used for the development or implementation of any investment strategy. It should not be construed as an investment advice to any party. All opinions, figures, estimates and data included in this article are as on date. The article does not warrant the completeness or accuracy of the information and disclaims all liabilities, losses and damages arising out of the use of this information. The statements contained herein may include statements of future expectations and other forward-looking statements that are based on our current views and assumptions and involve known and unknown risks and uncertainties that could cause actual results, performance or events to differ materially from those expressed or implied in such statements. Readers shall be fully responsible/liable for any decision taken on the basis of this article. The recipient should exercise due caution and/ or seek professional advice before making any decision or entering into any financial obligation based on information, statement or opinion which is expressed herein.
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