Why passive funds should be part of investor’s portfolio

ICICI Prudential AMC’s Chintan Haria shares his 2024 market outlook with THE WEEK

Chintan Haria Chintan Haria, principal - investment strategy, ICICI Prudential AMC

In the last few years, domestic investors have begun investing in stock markets, either directly or through mutual funds, in a big way. Passive investment strategies like index funds, where the fund replicates a particular index, have also gained ground. Equity mutual funds saw net inflows of Rs 1.44 lakh crore between January-November, which coupled with rebound in investments by foreign institutional investors, drove Sensex and Nifty50 to record highs. In an interview with THE WEEK, Chintan Haria, principal - investment strategy, ICICI Prudential AMC equity markets shares his outlook 2024, why he believes passive funds should be part of an investor's portfolio and whether they will outperform their active peers this year.

Q. Equities gave strong returns in 2023. What were the key drivers? Will 2024 be another good year?

In 2023, Indian equity market rallied on account of the resilience in the Indian economy and the robust growth in corporate earnings. This was at a time when most of the developed economies were facing various challenges. Going forward, in 2024, we expect the Indian economy to be strong and stable. Along with the urban segment, we expect buoyancy in rural economy ahead of the elections, which is a positive for equity markets. While the market valuations are not cheap, what could support the market at these levels is growth in corporate earnings along with steady GDP growth, decline in interest rates in the US and a potential bounce back in China. So, investors can remain invested in equities but one should not lose sight of risk management practices and asset allocation.

Q. In the last 2-3 years, we have seen growing participation among investors for index funds. Their AUM has risen from Rs. 1.24 lakh crore in Nov. 2022 to Rs 1.91 lakh crore in Nov. 2023. Why? How do you view this trend going ahead?

Investors over the past few years have been increasingly embracing passive strategies such as index funds and ETFs (exchange traded funds) when it comes to taking exposure to benchmark indices. This has been the result of improving investor awareness among the masses and increasing comfort around including passive strategies as a part of one’s portfolio. We believe this trend will continue in the times ahead.

Q. ETF AUMs have also risen, but generally the interest among Indian investors has been limited and restricted to certain ETF categories only, even as India-tracking ETFs in global markets have seen huge inflows in 2023. Why?

Over the past few years, with the rise in the number of demat accounts and market participants, the interest in ETFs and index funds has significantly improved. Also, larger number of asset management companies now focusing on passives by launching a variety of passive offerings has further helped to improve the popularity of passive investing. While it is true that most often the interest is limited towards benchmark indices based offerings, at ICICI Prudential AMC, in 2023, we saw increased traction among the investors for smart beta strategies like momentum, alpha low vol and low vol. Also, sectoral offerings based on banks and IT saw investor interest.

Q. Should retail investors look at ETFs in a big way? Which are the categories among ETFs likely to see good traction?

When it comes to equity investing, investors have the option of direct investing, actively managed mutual funds, index funds, ETFs and PMS. Within these, ETF is one of the more transparent and low cost investment avenue. Using a combination of these, investors today can create a balanced portfolio. We recommend at least 20-25 per cent of an investor's portfolio should be in passive funds. Going forwards, we believe smart beta strategies or factor based investing to see good traction.

Q. Over the last 2-3 years, we saw passive funds outperforming their active equity counterparts. But that trend seems to be reversing. What is your view on this?

Over the last two decades, there have been distinct phases when active and passive funds have done well. For example: 2003-2007, 2013-2017, 2022-2023 were phases when active did well. On the other hand, 2008-2010 and 2018-2021 were phases when passive investing did well. So, over a complete market cycle, there will be times when active or passive will perform well but we cannot predict when such phases will occur.

In retrospect, we know that active strategies tend to do well when there is buoyancy in the economy, bounce back in corporate earnings and a wide set of sectors participate in the market upmove. When the reverse is true and a narrow set of companies are propelling the market, a passive approach tends to work well. So, the optimal approach is to maintain a balance between active and passive strategies in the portfolio.

Q. In a broader market rally that we are seeing now, is there still a case for passive funds? Especially in small and midcap categories, where one needs a lot of research on companies, what could be possible passive strategy?

In a broad market rally, it is difficult to pinpoint which segment would do well, especially within the midcap (150 stocks) and smallcap space (250 stocks) since the room for stock selection is very wide. In an actively managed fund, we could have a portfolio of 30-50 stocks which would work very well during a secular up move. However, during the other market phases, a passive approach can be helpful. But the caveat here during times of a market correction, there is no risk management framework on the passive side. So, the downside will also be the same as the index unlike active funds wherein the fund manager can step with downside protection maneuvers. With this understanding investors will have to maintain a balance between passive and active strategies within the mid and smallcap space.

Q. Gold has seen a good surge in 2023, do you see further potential in yellow metal going forward in 2024? What are the triggers for Gold ETFs in 2024?

We believe gold will continue to remain attractive in 2024. Traditionally, when the US Fed cuts rates, gold price tend to move up. Also, the growing inclination of global central banks towards yellow metal over US Treasuries as a means of hedging portfolio risk could lend support to the yellow metal.

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