Passive investing is the simplest form of investment. It can also be called rules-based investment where there is no human intervention. Most passive funds in India are based on broad market indices which simply put together a group of companies based on their market cap size and then weigh them using free float market capitalization.
While passive investing should be known for its simplicity, we are guilty of overcomplicating the narrative. As an investor, the first thing you ask about an investment option is its ability to generate returns. Now, this is a fairly simple question that deserves a simple answer. Something along the lines of x% should suffice. However, what you hear instead is, ‘active funds may not generate alpha’ or ‘it will beat actively managed funds’. Unfortunately, this doesn’t answer your question and leaves you more confused than before.
Similarly, another term that has become synonymous with passive investing is ‘low cost’. While costs are important, a few basis points should not be the only criterion for choosing a fund. In addition, the cost is not constant and may change. For example, in recent years, the cost of passive funds has increased slightly while the cost of active funds has decreased. Some direct alternatives to active funds are available at an expense that is equal to or less than some passive funds. When we talk about alpha and low cost as the only benefits of passive investing, we tend to limit our communication to people who understand that language and are probably already investing in equities. This leaves a large group of potential investors looking only for simple investment solutions that can generate returns better than traditional investments such as fixed-deposit, gold and real estate.
Passive funds solve basic problems faced by both new and experienced investors. They are simple and can be used for effective portfolio diversification. They are like lentils and rice which are simple and liked by almost everyone. On the other hand, there may be some people who also love biryani, which is equally good and has its own appeal. We love dal-chawal for its simplicity and flavour, not because it is light on our wallet.
Passive fund for new investors
Choosing the right investment fund for your portfolio can be a daunting and daunting task for new investors, especially if you do not have an expert. You have to first understand your portfolio requirements and then find the right fund by studying the fund’s style, performance across cycles, risks etc. and continue to review and track the fund continuously. This is a difficult task for new investors.
Passive funds for such investors like index funds There is an easy option. Index funds are simple, easy to choose and low cost to track, and offer market-linked returns. Yes, index funds are doing better than some active funds, but there are also some active funds that are outperforming index funds. Thus, alpha isn’t the only reason to invest in index funds. Passive funds can also be a great option for all those investors who prefer a do-it-yourself investment (DIY) approach.
Passive Funds for Experienced Investors
Investors who already have a portfolio of active funds can add passive funds to complement their portfolios and potentially increase their risk-adjusted returns. Adding passive funds to a portfolio can reduce some of the risk of underperformance that can come with an active fund in the short term due to different investment styles.
Equally important are the diversification benefits of passive funds that can be enjoyed by both new as well as experienced investors. When you invest in an index fund, you get exposure to all the components of the index through a single investment. For new investors, this is a great way to enjoy the benefits of diversification, while for experienced investors, it is a great way to complement their existing portfolio.
There is a lot of potential for passive in India provided it is packaged in the right box which is suitable for investors. I think the stage at which people will invest in passive for its simplicity is ahead of the stage where they will invest because active is not generating alpha. Either way, passive funds are multi-faceted in nature and are likely to gain further momentum in India.
(The author is Head – Products, Marketing & Digital Business, Edelweiss AMC.)