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Passive Funds
If
you were to look at the October flows into equity funds, one thing that
will hit you is the big shift to passive. Index funds and index ETFs
saw flows of Rs.6,000 crore in October almost equal to the total flows
of all equity oriented active funds. But that is not all. In the last
five years, the AUM of passive index funds in India has moved up sharply
from Rs.3,500 crore to Rs.1,85,000 crore and this figure promises to
only grow further. The AUM of passive index funds in India is just about
6% of the total AUM compared to 35% in the US, but the shift has surely
begun. Here is why index funds are attractive.
Impacted by volatility
To
be fair, it is not just about volatility but about how the returns are
getting concentrated in just a handful of stocks. For example, if you
leave out TCS, RIL, HDFC Bank, ICICI Bank and HUVR, then the Nifty would
have actually under-performed in the last one year. Active funds cannot
concentrate their portfolio in a handful of stocks as it goes against
the basic grain of diversification. The moment they have spread their
holdings in this market, these active funds have underperformed. You
just need to look at the numbers. In 2019, active funds earned a median
return of 5.3% against 9.3% for the passive funds. In the year 2018,
active funds had given negative returns while funds had yielded positive
returns of 2.3%. This differential is driving money towards passive
funds.
Regulations played a role too
In
2018, SEBI undertook a revamp of mutual fund regulations and one of the
key areas was in MF classification. MFs were allowed to have only one
category per AMC and each of these categories had to adhere to a strict
definition. For example, a large cap fund had to have an exposure of at
least 85% to large cap stocks. Mid cap funds had to keep an exposure of
minimum 75% to mid cap stocks. SEBI even standardized the definition of
large caps, mid caps and small caps by giving them a market cap related
interpretation. This largely took away the leeway that funds had enjoyed
in the past where they could tweak their holdings in search of alpha.
This tighter regulation shaved off most of the alpha returns of active
equity funds.
Costs matter in tough times
Nobody
bothers about costs in heady bull markets but in tough times, these
costs come home to roost. For example, the median cost (TER) of a
regular large cap fund is around 2.45%. Even a direct plan of a large
cap fund charges about 1.6% on an average. Compared to that, equity ETF
has a TER of just 0.29%. This 200 bps difference between a passive fund
and an active fund makes all the difference to the eventual net return.
It does look like Indian mutual funds are seeing a gradual passive
shift. Like the world over, Indian investors are lapping up index funds
and ETFs!
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