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Passive Investing Surge: India's Passive Mutual Funds Hit 17% of Total AUM

Passive Mutual Funds Surge in Popularity: Now Command 17% of Total AUM, Reveals Motilal Oswal Report

In the ever-evolving landscape of India's mutual fund industry, passive investment strategies are rapidly gaining ground, reshaping how investors approach wealth creation. According to a recent report by Motilal Oswal Financial Services, passive mutual funds, including exchange-traded funds (ETFs) and index funds, have seen their assets under management (AUM) soar to an impressive Rs 10.2 lakh crore as of August 2024. This figure represents a significant 17% of the total mutual fund AUM in the country, which stands at Rs 61.1 lakh crore. This marks a notable increase from just 15% a year earlier, underscoring a shift in investor preferences toward low-cost, rule-based investment vehicles that mirror market indices rather than relying on active stock-picking.

The rise of passive funds is not merely a statistical blip but a reflection of broader trends in the financial markets. Passive investing involves funds that track a specific benchmark index, such as the Nifty 50 or Sensex, without the need for fund managers to actively select stocks. This approach contrasts sharply with active funds, where managers aim to outperform the market through research and strategic decisions. The Motilal Oswal report highlights that the passive segment has grown at a compound annual growth rate (CAGR) of over 35% in the last five years, outpacing the overall mutual fund industry's growth. This acceleration is driven by several factors, including the consistent underperformance of many active funds against their benchmarks, especially in the large-cap space, and the allure of lower expense ratios in passive products.

Delving deeper into the data, the report breaks down the composition of passive AUM. ETFs dominate the space, accounting for approximately 80% of the total passive AUM, with index funds making up the remaining 20%. Gold ETFs, in particular, have emerged as a popular choice, offering investors exposure to gold prices without the hassles of physical storage. The report notes that the number of passive schemes has proliferated, with over 200 such funds now available, covering a wide array of themes from broad market indices to sector-specific and smart-beta strategies. This diversity has made passive investing accessible to a broader audience, including retail investors who previously shied away from mutual funds due to complexity or high costs.

One of the primary drivers behind this traction is cost efficiency. Passive funds typically charge expense ratios as low as 0.05% to 0.2%, compared to 1-2% for active funds. This difference can significantly impact long-term returns, especially in a market where beating the index consistently is challenging. The Motilal Oswal analysis points out that in the large-cap category, a majority of active funds have failed to outperform their benchmarks over the past three to five years. For instance, data from the report indicates that only about 30-40% of large-cap active funds beat the Nifty 100 index in recent periods, prompting investors to question the value added by active management fees.

Regulatory initiatives have also played a pivotal role in boosting passive funds. The Securities and Exchange Board of India (SEBI) has been proactive in promoting index-based products, including mandating benchmarks for performance evaluation and encouraging the launch of passive funds by asset management companies (AMCs). The introduction of the Employees' Provident Fund Organisation (EPFO) investing in ETFs has further institutionalized passive strategies, channeling massive inflows into these funds. According to the report, institutional investors, including pension funds and insurance companies, now contribute a substantial portion of passive AUM, viewing them as stable, diversified options for long-term portfolios.

The growth trajectory of passive funds in India mirrors global patterns, albeit at a nascent stage. In mature markets like the United States, passive funds account for over 50% of total mutual fund AUM, as per industry benchmarks. The Motilal Oswal report suggests that India could follow a similar path, potentially reaching 25-30% passive AUM share in the next five years if current trends persist. This optimism is fueled by increasing financial literacy, digital platforms making investments seamless, and a growing appetite for systematic investment plans (SIPs) in index funds. SIP inflows into passive funds have surged, with monthly contributions crossing Rs 2,000 crore, indicating sustained retail participation.

However, the report doesn't shy away from addressing potential challenges. While passive funds offer simplicity and lower costs, they are inherently tied to market performance, meaning they don't provide downside protection during corrections. In volatile periods, active funds might offer better risk management through tactical allocations. Additionally, the proliferation of niche passive products, such as thematic ETFs on EVs or renewables, introduces concentration risks if not diversified properly. The analysis emphasizes the importance of investor education to ensure that passive investing is used as part of a balanced portfolio rather than a one-size-fits-all solution.

Looking at specific segments, the debt passive space is also gaining momentum, though it lags behind equity. Debt ETFs and index funds, which track government securities or corporate bond indices, have seen AUM growth to around Rs 1.5 lakh crore, driven by investors seeking stable returns amid equity market uncertainties. The report forecasts that as interest rate cycles evolve, debt passives could attract more inflows, especially from conservative investors.

From an industry perspective, major AMCs like UTI, HDFC, and SBI have ramped up their passive offerings, launching innovative products to capture market share. The entry of new players and collaborations with global index providers like MSCI and FTSE have enriched the ecosystem. The Motilal Oswal report includes case studies of successful passive funds, such as the Nifty 50 ETF, which has delivered returns closely aligned with the index while maintaining liquidity through exchange trading.

Investor behavior is another focal point. The report reveals that millennials and Gen Z investors, who form a growing demographic in mutual funds, prefer passive options due to their tech-savvy nature and aversion to high fees. Digital apps and robo-advisors have democratized access, allowing even small-ticket investments. This shift is evident in the folio count for passive funds, which has crossed 2 crore, a testament to broadening participation.

In terms of performance metrics, the report provides comparative analysis. Over the last decade, passive funds tracking the Sensex or Nifty have delivered compounded returns of 12-15%, often matching or exceeding active peers after accounting for fees. This has led to a debate on the "active vs. passive" paradigm, with the report concluding that while active funds may shine in mid- and small-cap segments due to market inefficiencies, passives are increasingly the default choice for large-cap exposure.

The future outlook painted by Motilal Oswal is bullish. With India's economy projected to grow at 7-8% annually, passive funds are well-positioned to benefit from broad market upswings. Innovations like factor-based indexing (e.g., value, momentum) and ESG-themed passives are expected to drive further adoption. The report recommends that investors allocate 40-60% of their equity portfolio to passives for core holdings, supplementing with active funds for satellite strategies.

In conclusion, the ascent of passive mutual funds to 17% of total AUM signifies a maturation of India's investment landscape. As per the Motilal Oswal report, this trend is likely to accelerate, driven by cost advantages, regulatory support, and evolving investor preferences. While challenges remain, the passive revolution promises to make investing more inclusive and efficient, potentially transforming how millions build wealth in the coming years. Investors would do well to stay informed and adapt to this paradigm shift for optimal portfolio outcomes.

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Read the Full The Financial Express Article at:
[ https://www.financialexpress.com/money/passive-mutual-funds-gaining-traction-now-17-of-total-aum-motilal-oswal-report-3935771/ ]