Pankaj Shah, a 33-year-old Delhi basedmarketing professional, began investing in 2007. He started with actively managed diversified equity funds, picking them on the basis of their past returns and ratings.
Despite his diligence, Shah's choices fared poorly. The performance of a five-star fund tanked, sinking to three stars within a year. When this recurred, he switched to passive funds. "With actively managed funds, it is difficult to predict the ones that will do well. The past returns and star ratings are no guarantors of performance. Being busy, it is difficult for me to change funds regularly.
Besides, why should I pay a high expense ratio for a three-star fund?" he says. As for passive funds, he adds, "These may not outperform, but there is no risk of underperformance either, and the expense ratio is low." Like Shah, a growing band of investors in India is turning to passive funds—index funds and exchange traded funds(ETFs).
The advantages
Suited to efficient markets: Globally, it has been witnessed that as markets become more efficient, it becomes harder for fund managers to beat their benchmarks. Passive fundsprogressively become the preferred investment vehicle in such markets. In the Indian market's most efficient segment, the large-cap space (funds with more than 80% allocation to large-cap stocks), passive funds have a significant presence.
Despite his diligence, Shah's choices fared poorly. The performance of a five-star fund tanked, sinking to three stars within a year. When this recurred, he switched to passive funds. "With actively managed funds, it is difficult to predict the ones that will do well. The past returns and star ratings are no guarantors of performance. Being busy, it is difficult for me to change funds regularly.
Besides, why should I pay a high expense ratio for a three-star fund?" he says. As for passive funds, he adds, "These may not outperform, but there is no risk of underperformance either, and the expense ratio is low." Like Shah, a growing band of investors in India is turning to passive funds—index funds and exchange traded funds(ETFs).
The advantages
Suited to efficient markets: Globally, it has been witnessed that as markets become more efficient, it becomes harder for fund managers to beat their benchmarks. Passive fundsprogressively become the preferred investment vehicle in such markets. In the Indian market's most efficient segment, the large-cap space (funds with more than 80% allocation to large-cap stocks), passive funds have a significant presence.
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The category has 45 active funds (only primary funds included) and 30 passive ones. Their cumulative asset under management (AUM) is small: Rs 1,758 crore vis-a-vis Rs 24,663 crore for active funds. However, their proliferation indicates that fund houses are preparing for the day when investor preference might shift to passive funds in this segment.
Low expense ratio: The prime attraction of passive funds is in their low cost. In recent times, while expense ratios have fallen in the passive fund space, they have risen in active funds. The most inexpensive index fund and ETF both have an expense ratio of 25 basis points. The median expense ratio for ETFs is 59 basis points, and for index funds, 1.5%.
Low expense ratio: The prime attraction of passive funds is in their low cost. In recent times, while expense ratios have fallen in the passive fund space, they have risen in active funds. The most inexpensive index fund and ETF both have an expense ratio of 25 basis points. The median expense ratio for ETFs is 59 basis points, and for index funds, 1.5%.
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