Passive Investing is a strategy that seeks to maximise returns by minimising trading. Followers of this philosophy believe that it is not possible to continuously beat the market, especially in the long run. Hence, constant buying and selling are unnecessary and return eroding activity.
Passive Funds, thus, are mutual funds that invest in the same stocks like that of the underlying index and seek to achieve similar returns as that index. Examples of passive investing are Index Funds and Exchange Traded Funds (ETF).
Low Cost
Fund managers of passive funds do not need to proactively monitor the market or take investment related decisions. As a result, these funds charge lower management fees, which mean higher returns for you.
Transparent
As an investor, you have complete clarity on the stocks that the fund will invest in. There is no scope for ambiguity.
Simplicity
Unlike actively managed funds that require a dynamic strategy, constant market research, and alterations, life is simpler with passive funds.
According to a report by Morningstar, in the United States, the AUM of passive funds has surpassed that of actively managed funds in 2019. However, for India passive investing is a concept that is yet to become a household name. Despite a healthy performance track record, passive investing is yet to gain solid momentum in India. Index Funds and ETFs form a mere 6.5 per cent of the country’s total mutual fund assets.
Percentage of Funds outperformed by the Index
Category
Comparison Index
1-Year
3-Year
5-Year
10-Year
Large-Cap
S&P BSE 100
76.67%
82.93%
65.71%
61.34%
Tax Saving (ELSS)
80.95%
83.33%
51.35%
45.71%
Mid-Small Cap
S&P BSE 400 MidsmallCap Index
18.92%
47.83%
26.98%
48.84%
Govt. Bond
S&P BSE India Government Bond Index
76.92%
73.17%
84.62%
87.72%
Composite Bond
S&P BSE India Bond Index
(Source: S&P Dow Jones Indices, Morningstar and AMFI)
One major factor that is responsible for this slow growth of passive investing is the interest deficiency from distributors. For a country in which a majority of the retail investors depend on a broker, passive funds have a low expense ratio and thus low commissions create a conflict of interest.
Some commonly asked questions on passive investing
Can index and active funds co-exist in one portfolio?
Yes they can, but given the international and Indian evidence on passive out-performance you have to be really clear why you want to invest in active funds.
Are index funds suitable for a novice or a seasoned investor?
Yes, they are suitable for all investors. Low cost investing is good for everyone, be it a novice or a seasoned investor.
Isn’t passive investing riskier than active investing? Fund managers do not have the flexibility to change the allocation even if one of the stocks is under-performing.
Like any investment, index investing is also subject to overall market risk. For instance, index funds track a certain benchmark or indices. So, when the latter falls, the value of Index Funds will also go down. However, compared to actively managed funds, they face less volatility.
The author is the the Founder and CEO of Kuvera.in