The Buyt Desk
When you have no time or inclination to do the legwork of picking the investments and still want to invest in a portfolio of assets then passive funds is your answer. In India, passive investing is gaining recognition. In 2021 alone, AUM of around Rs 1,50,000 crore was acquired by nearly 50 passive schemes. Passive funds have made their impact this year by attracting a big inflow. This was not just limited to large-cap funds that were failing to beat the benchmark but even in other categories of funds, there was a robust inflow of funds from retail investors. Market experts say passive funds in India are winning.
What are passive funds?
Passive funds are the simplest form of investment that adds value to investor portfolios in many ways. It is a concept with an approach of buying and staying invested for a longer tenure. It is considered as a hands-off approach where one opts for security and then holds onto it through ups and downs for a very long period. Passive investments usually engage in buying shares of index funds or ETFs that try to replicate the performance of significant market indexes. The shares of these funds can be purchased through any brokerage account.
How do passive funds work?
Passive funds have no human intervention and are rule-based investing. In India, most passive funds are established on broad market indices. It puts together a cluster of companies as per their market cap size and is then weighed via free-float market capitalization. Passive investing doesn’t ask for frequent attention as it has a set-it-and-forget-it outlook that only tries to match market performance. Passive funds have lower fees as it has fewer transactions because of long term goals. These features make passive funds most desired for retirement savings and other investment goals. Passive funds are for both new and seasoned investors as they are simple and help in the diversification of portfolios.
Why passive investing?
Simplicity: It is easier and simpler to own an index or group of indices than a dynamic policy that needs constant research and adjustment. Passive funds do not need constant monitoring.
Lower costs: In 2021, the average expense ratio for passive mutual funds was 0.06% and passive ETFs 0.18%. Fewer transactions in passive investing will result in lower costs for individual investors. Passively managed funds have no human intervention and thus charge lower expense ratios. Also, very little research and upkeeping is needed in passive investing demanding ultra-low fees.
Decreased risk: Passive strategies are mostly fund-focused where investments happen in hundreds of stocks and bonds providing diversification. Diversification reduces the possibility of one failed investment making the whole portfolio a failure. The less risk is because of diversification.
Increased transparency: Index funds always have a clear asset view. No human intervention makes it tamper-proof and every asset is clearly visible.
Higher average returns: Long-term investment in passive funds of any kind normally gives higher returns.
Tax efficiency: As passive funds are long term, it doesn’t usually generate massive capital gains tax for the year.
Passive funds and new investor
For new bees in investment planning, passive funds are a simpler choice. As Index funds are simple, available at a low cost, can be selected and tracked effortlessly and market-linked returns make it easy for new investors. For investors who want to go for the Do-it-Yourself (DIY) approach in investing, passive funds are a good option to be considered. Alpha should not be the sole reason to invest in index funds as many funds perform well in the market.
Passive funds and seasoned investor
Investors with a portfolio of active funds can balance their portfolios by adding passive funds. This will enhance risk-adjusted returns in their portfolio. The passive funds in the portfolio may balance the risks of underperformance of active funds. The diversification benefits can be incurred by the addition of passive funds to the existing portfolio.
Conclusion
Investors who want to invest for the long term with minimum risks will go for passives. If the passive funds are packed in the right combination as per investors need, then passives have great potential in India. People will invest more in passive for various reasons other than alpha. Its multifaceted nature will attract more investors. Passive funds have benefits of diversification and complementing existing portfolios. New and seasoned investors can also invest a part of their portfolio in passive funds for diversifying their portfolios.
