The rapid rise of passive investing in India 

Passive investing or passive funds have been in the news ever since new-age fund houses – and also some of the old, traditional ones – started betting big on them. A cursory glance through the filings for new schemes shows that fund houses are now all set to pitch exchange traded funds (ETFs) and index funds to the growing investor community.

While the passive fund segment is buzzing with activity and it is a fact that the last couple of years have seen a stupendous growth in terms of investor interest and growth in assets under management (AUM), India has still a lot of catching up to do in an arena that is huge globally but still in its nascency in the country.

Passive investing or passive funds refer to schemes that replicate a particular index. In other words, the scheme would have stocks or securities in a similar weightage as its benchmark index. An index fund or an ETF is the most common example of passive funds.

A latest report by Finity, a fintech specialising in passive and direct mutual fund schemes, estimates the AUM of passive funds to cross Rs 25 lakh crore by March 2025 from Rs 3 lakh crore in March 2021. In other words, it estimates that the share of passive AUM in the overall assets of the Indian mutual fund industry will surge from 10 per cent as of March 2021 to 37 per cent in March 2025.

Meanwhile, a report by BCG on the global asset mix of mutual funds showed that the AUM of passive funds was pegged at $22 trillion in 2020, which is expected to rise to $34 trillion in 2025. Interestingly, passive products recorded their highest growth in the pandemic-affected year as the AUM rose 17 per cent globally, as per the BCG report.

Back in India, historical data shows that the AUM of passive funds has jumped ten-fold in just three years from 0.8 per cent in March 2018 even as the low-base effect cannot be ignored. Between March 2016 and March 2021, the AUM of passive funds rose from Rs 22,409 crore to Rs 3,10,330 crore, reflecting a CAGR of 69 per cent. 

As of September 2021, there were around 160 passive schemes in India. Interestingly, the country’s largest fund is a passive scheme - SBI ETF Nifty 50 fund – with an AUM of over Rs 1.1 lakh crore as of September 2021.

“The trend of the shift of assets from active to passive management seen over the past decade has started showing up strongly in India. Passive assets, customer folio accounts in passive assets, passive products (ETFs & Index), and passive assets as a percentage of overall assets have more than doubled in the previous five years,” stated the Finity report.

According to the study, three factors contributed to the rise in popularity and AUM of passive funds – underperformance of active funds, cost and the regulatory & government policies.

The report further highlighted the fact that over 80 per cent of the funds in the equity large-cap category underperformed the benchmark over one, three, and five-year periods as of June 30, 2021. More importantly, the average expense ratio of large-cap funds in India is around 1.5 per cent while passive products are typically in the range of 0.05 -0.3 per cent.
“This difference may seem insignificant, but over a long period, these costs add up. The cost of funds is considered a significant factor in value creation over the long term,” said the report.

The scope for growth of passive investing can be further gauged from the fact that in the US – the largest mutual fund market globally – passive assets rose from $2 trillion to $10.3 trillion in the last decade as of December 2020, showcasing an absolute growth of 410 per cent and a CAGR of 18 per cent.

Passive assets now account for around 35 per cent of the overall assets in the US, as per the report.

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