Passive is the way to get ‘active’ returns

The passive mode of investment through exchange traded funds (ETFs) is gaining ground in India, similar to developed countries. According to the data from the Association of Mutual Funds in India (AMFI), ETFs attracted Rs 24,083 crore in the first eight months of FY20. This was about double of the inflows in large-cap funds and half of the total inflows in equity funds during the period. The combined inflow in the equity schemes was Rs 48,891 crore between April and November 2019.

The lower expense ratio, market polarisation in favour of select large-cap stocks, converging returns with that of the large-cap funds, and investment by provident funds into equity markets through ETFs are the key reasons for their rising clout.

The median expense ratio of the ETF funds benchmarked to the Sensex and Nifty is 0.1% compared with 2.3% for large-cap funds according to Accord Fintech. Also, the top five stocks by weights contributed over 60% to the Nifty 50 returns in 2019 reflecting the concentrated nature of the index rally. An active fund manager of a large-cap fund would find it difficult to beat highly polarised index returns. In such a scenario, ETFs offer a better investment alternative since they bet on the entire index rather than on its select component stocks.

The assets under management (AUM) of the ETF stood at Rs 1.63 lakh crore in November 2019, higher than the total AUM of the large cap funds in India. There were 72 ETF schemes at end of November compared with 30 large-cap schemes.

The AUM of ETFs grew by 24.9% between April and November while total equity AUM grew by 8.4% in the same period. Its share in the total equity AUM rose by 200 basis points to 17.7% since the beginning of the fiscal.

In the US, the gap between the AUMs of active and passive funds has narrowed significantly over the past decade. Currently, the passive funds’ AUM is $8.6 trillion compared with $11.8 trillion for the active funds. In 2009, the figures were $1.6 trillion and $6.2 trillion in that order.