It is no longer a secret that Indian investors love mutual funds. Some Rs26,500 crore goes to mutual funds every month via systematic investment plans (SIPs) alone, and it has helped offset the massive outflow of money from foreign institutional investors in the recent months.
A big driver of that surge is index funds and exchange traded funds (ETFs), or passive funds, as they are called. Simplicity is the highlight of passive funds, which makes them especially popular among new investors. A Sensex index fund, for instance, will mirror the Sensex and most of the investments in this fund will be in the 30 shares that make up the benchmark. A US S&P 500 index fund will invest in the top 500 global corporations that make up the S&P 500 stock index in the US.
There were as many as 515 funds in the passive space as of December 2024. In the last financial year (2023-24), the inflows into passive funds were at Rs63,832 crore. This year, it surged to Rs1.08 lakh crore in just three quarters (April-December). The assets under management in passive funds stood at Rs10.85 lakh crore as of December 2024, a bulk of them in equity funds. Passive funds now account for 16 per cent of total mutual funds AUM.
“The rapid growth of the passive investment space in India is driven by a combination of factors, including rising investor awareness about cost-efficient and transparent products, growing institutional participation from entities, and the regulatory push for low-cost investment options,” said Chintan Haria, principal, investment strategy, ICICI Prudential Mutual Fund. The fund house has strategically launched index funds across various market segments and themes to cater to diverse investor preferences and to ensure broad market access, he said.
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A low expense ratio is an advantage that passive funds have. Compared to the active funds, where fund manager is actively taking decisions on buying and selling the stocks in a scheme, index funds, which typically align to indexes, have low cost.
For instance, the large-cap oriented ICICI Prudential Bluechip Fund regular scheme had an expense ratio of 1.45 per cent. On the other hand, ICICI Prudential Nifty50 index fund, which tracks the benchmark large-cap index, had an expense ratio of just 0.36 per cent. Motilal Oswal MF’s mid-cap regular scheme had an expense ratio of 1.58 per cent, while its mid-cap 150 index fund had 1.00 per cent expense ratio. Axis MF’s small-cap regular scheme had an expense ratio of 1.61 per cent, while Axis Nifty small-cap 50 index regular scheme had an expense ratio of 1.02 per cent.
The fees charged in ETFs are even lower across fund houses. But you need a demat account to invest in ETFs. “Passive funds, including index funds and ETFs, generally charge much lower management fees compared to active funds. This cost advantage is a significant driver of investor preference; as lower fees directly enhance net returns over time,” said Vaibhav Porwal, co-founder of the wealth management platform Dezerv. Passive products provide straightforward exposure to market indices, sectors or themes without requiring in-depth analysis or active management decisions. This simplicity makes them attractive to investors who seek easy access to diversified portfolios, he added.
Of late, there have been a slew of launches in what is called factor funds or schemes that are based on a particular factor such as value, quality or momentum. Such funds may typically track an underlying index, but within that select stocks based on a particular factor.
The strong pull towards passive funds has also given rise to fund houses that launch only such schemes. Zerodha Fund House, a joint venture between the discount broking firm Zerodha and wealth management platform Smallcase, which was launched in August 2023, has seen its AUM touching 04,287 crore in less than 18 months. “In developed markets like the US, passive funds dominate due to market maturity, and the difficulty of consistently generating alpha and data is pointing to a similar trend in India,” said Vishal Jain, CEO, Zerodha Fund House. India needs rapid financialisation and it is crucial to have products that are easy to understand and adopt, thus passive products are poised to play a pivotal role, he added.
In the past, when equity markets were on an upswing, many active funds failed to beat benchmark indices. According to SPIVA (S&P Indices Versus Active Funds) India Scorecard, 51.6 per cent active managers did worse than the S&P BSE 100 benchmark in 2023. Underperformance rates were significantly high over the three- and five-year periods, at 87.5 per cent and 85.7 per cent, respectively.
The first half of 2024 proved to be an equally challenging environment for active fund managers. SPIVA data said that 77 per cent of actively-managed Indian equity large-cap funds trailed the S&P India Large Mid-cap’s total return of 17.4 per cent, posting an asset weighted average return of 14.5 per cent.
Against this backdrop, many investors may get attracted to passive funds. But, with markets turning volatile of late, and a broad-based rally unlikely, stock selection would become crucial and here active funds would have an advantage, say experts.
“Given the current starting valuations in 2025, broad-based multiple expansion is unlikely to drive equity returns. Consequently, we anticipate alpha to become the primary driver of returns, suggesting that active fund managers are well-poised to outperform traditional passive strategies in the medium term,” said Porwal.
Siddharth Oberoi, founder and chief investment officer at Prudent Equity, bats for a mix of active and passive funds in a portfolio. “Although data shows that many active funds struggle to outperform benchmarks, those that do succeed often deliver substantial returns. As a result, investors should consider prioritising active funds, with a smaller allocation to passive ones,” he said. As market volatility increases and the potential for high returns diminishes, many investors are turning to experienced professionals who offer actively managed solutions, he added.
Ultimately, it is a maze out there when it comes to investing, and there is no simple answer to choosing between active or passive funds. As Oberoi notes, there are nearly 1,000 active schemes across mutual funds, portfolio management services, alternative investment funds and other options. Choosing the right investment may become overwhelming for some investors. Therefore, assessing one’s risk appetite and getting expert advice when necessary may well be the right approach to investing.