What are passive funds or passive investments?

The Indian mutual fund space is seeing a paradigm shift, to say the least. Most of the new-age entrants that are betting big on technology have made it clear that they will focus on passive schemes. So, what exactly are passive funds and why is there is a rush to launch such funds? 

What are passive funds or passive investments?

Simply put, passive funds are those that replicate a particular index or a benchmark. An index fund or an exchange-traded fund (ETF) are the most popular examples of a passive fund. For example, a Nifty Fund of any mutual fund house would have the same 50 stocks in its portfolio that are part of the benchmark Nifty index of the National Stock Exchange (NSE). Similarly, any Sensex fund would have 30 stocks in its portfolio. Further, even the weightage of the stocks would mirror those in the index against which the scheme or the fund is benchmarked.

Are passive funds low-cost compared to the active ones?

Every mutual fund scheme has an expense ratio, which is basically the cost of managing the fund. It includes the costs incurred for marketing and advertising of the scheme, investment management fees and transaction costs among other expenses. An active fund has a higher expense ratio as one needs a proper fund manager to monitor the fund and take timely buy or sell decisions to maximise returns. A passive fund, on the other hand, simply needs to replicate the index and hence the role of a fund manager is passive in nature. If there is any change in the index, then the fund manager will make the corresponding change in the scheme too.  

Are passive funds better for investors?

This does not have a clear yes or no answer. Both, passive and active funds have their own set of benefits. Passive funds are for those who are only looking at investing in a particular index like Sensex, Nifty, S&P500 or the FTSE among others and are happy with the returns generated in line with a particular index. On the other hand, active funds typically aim to outperform the benchmarks and hence, may or may not, outperform over a certain period of time. Active funds are for those who are ready to bet on the fund managers' investment management skills to get a higher return than the benchmarks.

Why are passive funds in the news?

The Indian mutual fund industry is seeing a lot of new players coming in and most of them are betting big on passive funds. Interestingly, these fund houses are even getting theme-based passive schemes that are typically aimed at young or millennial investors.

Navi Mutual Fund - founded by Flipkart founder Sachin Bansal - has already filed a draft document with the Securities and Exchange Board of India (SEBI) for 11 passive fund schemes including, Pharma Index Fund, IT Index Fund, Nifty Bank Index Fund and Nifty Midcap 150 Index Fund among others. It further plans to launch Navi Electric Vehicles and Driving Technology Fund of Fund, which will invest in overseas exchange-traded funds (ETFs) and index funds based on STOXX Global Electric Vehicles & Driving Technology NET Index.

Zerodha Mutual Fund has also stated in the past that it would launch passive funds so that investors get access to low-cost investment options. Earlier this week, HDFC Mutual Fund, which is known for its actively managed funds, filed the draft document for nine ETFs.

Were passive funds always popular in India?

Passive funds are huge globally though such funds are still a minority in India. But one can safely say that the numbers are fast rising. Data from Morningstar shows that the total AUM of passive funds has risen at a much faster pace than that of active funds though the low-base effect has also played a key role.

As of July 2021, the total AUM of passive funds was pegged at Rs 3.82 lakh crore, much lower than the AUM of Rs 31.05 lakh crore of active funds. The rise in AUM in the one-year period till July 2021, however, was much higher for passive funds at nearly 63 per cent compared to 34 per cent for active funds. Further, while a total of 11 passive funds were launched in 2018, the number rose to 23 in 2020 and 32 till July in 2021, as per data from Morningstar.

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Also Read: HDFC Mutual Fund files documents for 9 Exchange Traded Funds