Passive funds outrun active peers in chase for inflows

ET Intelligence Group: Odds are rather long that you'd take Humphrey Appleby's prescription for success on face value, but 'masterly inactivity' does indeed seem to work pretty well in the world of investing.

So, 'passive' funds have emerged as tough 'challengers' to active funds lately. Total inflows into passive funds - index funds, ETFs and Fund of Funds (FoF) for overseas markets - have cumulatively risen to ₹89,169 crore in the past year. That outguns flows into active equity mutual funds by two and a half times, data from AMFI showed.

ETF as an asset class has been the highest contributor to passive fund inflows, with a share of 65%, followed by index funds (19%) and FoF of the overseas market (16%). Inflows into passive funds have remained steady for 12 months in a row, while active equity funds got inflows in 8 of the last 12.

Average inflows into passive funds have been ₹7,430 crore in the past year, while large-cap mutual funds witnessed a contraction in net inflows in the same period. Passive inflows that are so far concentrated on ETFs are gradually picking up in index funds, too. Cumulative inflows in index funds are ₹8,552 crore between August to October 2021.

Retail inflows are gradually playing a pivotal role in the incremental inflows, as is evident in the buoyancy in folio editions for index funds and ETFs.

Index funds folio addition has been in the range of 0.95-1.53 lakh in the last three months compared with one year average of 0.60, while the ETF folio addition 4.47-5.62 lakh a month between August and October 2021, one of the highest additions in the active and passive funds in the same period.

The passive fund folio ratio to the total equity fund folio rose to 12% in October 2021, which is nearly double the last year's level.

Passive funds now make up a third of the pooled assets under management (AUM) in active equity funds, a record high level. The total AUM of the passive funds stood at ₹4.31 lakh crore in October 2021, 11% of the total domestic fund AUM.

Risk-adjusted returns of passive funds are now superior to active funds. For instance, one-year returns of the top 10 large-caps by AUM have been 47.8%, while the top ETF by AUM delivered a return of 46% in the same period. So, the incremental 180 basis points returns for higher volatility do not make sense for investors.

Second, AMCs are launching new products such as Smart Beta which are theoretically passive but have some active characteristics too. The awareness of Smart Beta products is picking up and index construction companies have launched indexes based on value, quality, and alpha.

Finally, fund management fees on passive funds are a tenth of the large-cap funds. This lowers the cost of ownership by up to 150 basis points, consequently amplifying returns as well.