Passive Funds: Passive funds outperform active peers looking for inflows

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ET Intelligence Group: The odds are pretty long that you will take Humphrey Appleby’s recipe for success on face value, but “masterful inactivity” really seems to work quite well in the world of invest.

Hence, lately “passive” funds have emerged as difficult “challengers” for active funds. Total inflows in passive funds – index funds, ETFs and Fund of funds (FoF) for foreign markets – increased cumulatively to ₹ 89,169 crore in the last year. AMFI data showed that outguns flow into two and a half times active equity mutual funds.

The ETF as an asset class was the largest contributor to passive fund inflows, with a share of 65%, followed by index funds (19%) and foreign market FoF (16%). Inflows to passive funds have remained stable for 12 consecutive months, while active equity funds have seen inflows in 8 of the last 12.

Average inflows into passive funds have been ₹ 7,430 crore over the past year, while large cap mutual funds have seen a contraction in net inflows over the same period. Passive inflows hitherto concentrated in ETFs are gradually picking up in index funds as well. Cumulative inflows into index funds are 8,552 crore between August and October 2021.

Retail inflows are gradually playing a pivotal role in incremental inflows, as is evident in the liveliness of folio editions for index funds and ETFs.

The addition of the index funds folio has been in the range 0.95-1.53 ​​lakh over the past three months compared to the one-year average of 0.60, while the addition of the ETF folio of 4.47-5, 62 lakhs per month between August and October 2021, one of the highest additions to active and passive funds in the same period.

The ratio of the fund’s passive portfolio to the total equity fund portfolio rose to 12% in October 2021, nearly double the level of last year.

Passive funds now represent a third of assets under management (AUM) in active equity funds, a record high. Total AUM of passive funds stood at ₹ 4.31 lakh crore in October 2021, 11% of the total AUM of the domestic fund.

The risk-adjusted returns of passive funds are now higher than active funds. For example, the one-year returns of AUM’s top 10 large caps were 47.8%, while AUM’s first ETF produced a return of 46% over the same period. Hence, the incremental returns of 180 basis points for higher volatility make no sense to investors.

Secondly, AMCs are launching new products like Smart Beta which are theoretically passive but also have some active features. Awareness of Smart Beta products is increasing and index building companies have launched indices based on value, quality and alpha.

Finally, fund management fees on passive funds are one tenth of large cap funds. This reduces the cost of ownership by up to 150 basis points, thereby amplifying returns as well.

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