Why passive mutual funds are attracting more investors?

Passive mutual funds are gaining popularity due to the underperformance of active mutual funds, the introduction of debt passives, and the continuous introduction of new products. Continue reading to learn more.

Passively managed mutual fund schemes are becoming increasingly popular among Indian investors. According to the latest Association of Mutual Funds in India (AMFI) figures, monthly net flows into passive mutual funds (index funds and Exchange Traded Funds) were RS 10,260 crore in October, roughly three times that of active mutual funds, which were about Rs 3,872 crore. This is the largest net inflow multiple seen by this low-cost fund category in the previous 24 months compared to active mutual funds.

The category of passive mutual funds has experienced increasing monthly net inflows of Rs 2.6 lakh crore over the past two years with each month. Active mutual funds, on the other hand, received just 50 per cent, with a total net inflow of Rs 1.4 lakh crore.

Why Passive Funds Are Gaining Traction?

The underperformance of active mutual funds, the introduction of debt passives, and the consistent introduction of new offerings have fuelled the rise of the passive category, which now has over 320 open-ended offerings and accounts for 16 per cent (Rs 6.4 lakh crore) of mutual fund industry assets totalling Rs 39 lakh crore.

Since it invests in specific Exchange Traded Funds (ETFs), Employee Provident Fund Organisation (EPFO) inflows have enabled the passive mutual fund category to acquire size. Still, growing retail interest is seen in the expanding folio count. Passive mutual fund portfolios have grown quicker since the market crisis amid the pandemic but from a lower base. In March 2020, for example, the folio count for passive and active mutual funds was 32 lakh and 8.3 crore, respectively. While the number of passive folios has increased more than sixfold since then, the number of active mutual fund investor accounts has increased by just 42 per cent.

The exceptional growth of passive mutual funds

There were just a handful of passive mutual funds up until around five years ago, and they only managed to handle around Rs 1 lakh crore. This is a compilation of index funds, ETFs, and funds of funds (FoFs) that invest in foreign markets. However, the number of passive schemes more than tripled, and the number of assets under management increased roughly six times in only five years. Over 80 passive equity mutual funds and 50 passive debt mutual funds have been introduced in the past twelve months.

According to the most recent SPIVA India statistics, 50-90 per cent of active mutual funds underperform benchmarks in 3-, 5-, and 10-year periods across prominent categories like Large-Cap, ELSS, Mid-Cap, and Small-Cap. This has acted as a catalyst for passive mutual funds, which also have lower expense ratios than active mutual funds. Passive mutual fund offerings are typically 50-100 basis points less expensive than their active counterparts; however, this varies by category.

Final Thoughts

Although active mutual funds seem to underperform passive mutual funds, in the long run, few have proven to generate better alpha. Moreover, passive mutual funds outperform active mutual funds during the polarized market. Having said that, it makes complete sense to have a good mix of active and passive mutual funds.

Frequently Asked Questions (FAQs)

What are passive mutual funds in India?

To enhance gains, passive mutual funds constantly track a stock index. The portfolio of a passive fund is similar to that of an index fund such as Nifty, Sensex, etc. The same securities and investment percentages are employed in the fund's index as in the original.

Why passive mutual funds are better?

Passive funds address the fundamental concerns of both novice and experienced investors. They are simple and may be used to diversify a portfolio effectively. They are similar to dal-chawal, which is easy and well-liked by practically everyone. On the other hand, some people may enjoy biryani, which is also delicious and attractive. Enjoy the dal-chawal for its simplicity and flavour, not because it is cheap.