The landscape of investing in India is undergoing a fascinating shift. While active fund management has traditionally dominated the market, passive investing strategies are gaining significant traction.
Passive investing is an investment strategy that aims to replicate the performance of a specific market index or benchmark, rather than trying to outperform it. In most cases, this is achieved by investing in index funds or exchange-traded funds (ETFs) that track the performance of a particular index. Additionally, passive investments offer broad diversification, spreading risk across an entire market or sector, and they generally involve minimal trading, resulting in low turnover.
In passive investment, transparency is another hallmark, with holdings often readily available to investors, as passive funds seek to mirror specific indexes. Moreover, passive investing emphasizes a long-term approach, encouraging investors to adopt a buy-and-hold strategy rather than engaging in market timing or pursuing short-term gains.
The landscape of investing in India is undergoing a fascinating shift. While active fund management has traditionally dominated the market, passive investing strategies are gaining significant traction. A 2021 report by Finity paints a promising picture, estimating the Assets Under Management (AUM) of passive funds to balloon to a staggering Rs 25 lakh crore by March 2025. This would represent a monumental surge, with the share of passive AUM exploding from a mere 10% in March 2021 to 37% of the total mutual fund industry by 2025.
This trend isn't unique to India. A report by BCG reveals a similar global upswing, with passive products experiencing their strongest growth ever during the pandemic year, with global AUM rising by a significant 17%. The report said, “this trend is expected to continue over the next five years, with growth forecast at 9% annually. Although AuM for traditional and specialized active assets also expanded—with core products such as large-cap equity funds and domestic government-based fixed-income funds up by 11% during the year, money market funds up by 12%, and specialized active products up by 9%—the report forecasts that these will be the slowest-growing product groups over the next few years.”
An article by S&P Global further underscores this global phenomenon, highlighting that as of March 2020, a whopping $5 trillion was already invested passively worldwide, with over 7,000 passive products readily available. The article also stated that India's figures are comparatively modest, the growth trajectory is nothing short of impressive.
Just five years ago, India had a mere $2 billion and 57 products. A decade ago, the figures were even more modest, with just $1 billion and 26 products. However, India has witnessed a significant leap as total assets under management in passive products have reached a noteworthy $24 billion, with a healthy selection of 86 passive products available to investors. This progress is particularly remarkable considering the prevalence of a well-established active investing market in India.
Particularly, India’s exchange-traded fund (ETF) market has witnessed a phenomenal rise. Just two years before March 2020, ETFs constituted a mere 2.2% of the mutual fund industry. This figure had shot up to a robust 7.5% by December 2019, showcasing a clear shift in investor preferences. In fact, the country's largest fund by AUM is a testament to the power of passive investing – the SBI ETF Nifty 50 fund, boasting a colossal AUM of over Rs.1.5 lakh crores as of April 2023.
These figures and trends all point towards one thing: passive investing is rapidly evolving into a major force within the Indian investment landscape and is here to stay in India, given the 69% Compound Annual Growth Rate (CAGR) for passive fund AUM between March 2016 and March 2021.
As per Value Research, there were approximately 294 passive schemes offered in India, as of November 2022. Interestingly, with its focus on low costs, diversification, and potentially strong returns, passive investing offers a compelling alternative for investors seeking a simpler and potentially more efficient way to participate in the market.
The United States reigns supreme in this market, boasting a hefty 68% market share and a staggering $3.6 trillion in assets spread across more than 2,000 products. Europe and Japan follow closely behind, holding market shares of 16% and 6.5% respectively.
In Jan 2024, CNBC reported that Passive Investment rules the Wall Street.
“Passive investment products have long been pulling in the lion's share of money from investors, but as 2023 came to a close, they achieved a milestone: holding more assets than their actively managed counterparts. The total assets under management in exchange-traded funds and notes along with passively managed mutual funds reached a combined $13.29 trillion at the end of December, nudging above the $13.23 trillion held in active assets.”
The rise of passive investing in India can be better understood by looking at the factors that fueled its growth in the United States. According to an S&P Global Research report, active management in the US market has faced headwinds in four key areas: cost, professionalization, market efficiency, and the skewness of returns. Even in India, the results paint a similar picture as a majority of active funds underperform their benchmarks over various timeframes. Moreover, globally, underperformance is far more common than outperformance in active management.
The research report also attributed this underperformance to the rise in professionalization within the investment industry.
“Just like in the US during the 1970s, the Indian market is now seeing a dominance of professional investors. With everyone using advanced tools and strategies, the key factor distinguishing between success and failure is relative skill.”
This trend has sparked a demand for simpler and more efficient ways to engage with the market, driving the increasing popularity of passive options such as index funds.
The Skewness Factor: A Natural Advantage for Passive Investing
The concept of skewness in returns further strengthens the case for passive investing. Skewness refers to the asymmetry in return distribution, where positive outliers (outperformance) are more likely than negative ones (underperformance) when holding more stocks. This inherently benefits passive funds, which by design, hold a broad basket of stocks compared to actively managed funds with a more concentrated selection.
While India's passive investing landscape is still young, it is experiencing a growth spurt driven by local factors. A key driver is government investment by the Employees' Provident Fund Organization (EPFO) into Indian equity ETFs. Additionally, the Securities and Exchange Board of India's (SEBI) push for lower costs and greater transparency further incentivizes investors towards passive options.
Additionally, investor awareness is on the rise. Today, with easy access to resources and information, Indian investors are becoming increasingly knowledgeable about the benefits of passive investing. This newfound awareness is translating into a growing demand for index funds and ETFs.
Cost efficiency remains another major advantage for passive investing. Actively managed funds often come saddled with hefty expense ratios, which directly eat into potential returns. As Indian investors become more cost-conscious and seek to maximize their returns, they are likely to favor passive options. These funds typically boast significantly lower expense ratios, making them a more attractive proposition for the value-minded investor. This trend mirrors what has been observed in developed markets around the world, and India is poised to follow suit.
Finally, India's young and burgeoning population presents a vast potential for a surge in the adoption of passive investing. To sum it all, offering a cost-effective and well-diversified approach to wealth creation, passive investing is well-positioned to play a major role in the financial future of millions of Indians. The rise of passive investing in India can be attributed to both global trends and domestic tailwinds. As the Indian market matures and cost-consciousness increases, passive investing is poised to play an increasingly important role in investors' portfolios.
