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India's Index-Fund Boom Is Not a One-Size-Fit Solution, Says Vikas Khemani

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  Published in Stocks and Investing on Tuesday, December 23rd 2025 at 2:17 GMT by moneycontrol.com

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India’s Index‑Fund Boom Is Not a One‑Size‑Fit Solution, Says Vikas Khemani

A long‑running debate that has now come to a head is whether the rapid rise of passive index funds in India will continue to outpace active money management over the next decade. Vikas Khemani, a seasoned research analyst at MoneyControl, argues that the “alpha lies outside the indices” – a thesis that is becoming more convincing as more data comes to light.

1. The Growth of Passive Investing in India

Over the past five years, the Indian market has seen a surge in passive investment vehicles such as ETFs and index‑linked mutual funds. According to the latest data from the Securities and Exchange Board of India (SEBI), assets under management (AUM) in equity ETFs grew from roughly ₹7,000 cr in 2017 to over ₹70,000 cr in 2023 – a ten‑fold increase. Investors were attracted by lower expense ratios, transparency, and the promise of “buy‑and‑hold” efficiency.

The article references a SEBI report that details the market share of passive funds. The report shows that passive funds captured about 30 % of total equity market inflows in 2023, a significant jump from less than 10 % in 2018. Yet, the share of passive funds in the overall equity universe remains lower than in mature markets such as the United States, where passive accounts hold more than 50 % of total equity AUM.

2. The Alpha Gap: Where Index Funds Leave Money

Khemani’s central claim is that passive strategies are largely tracking the broad market index – the Nifty 50 or the BSE Sensex – while most of the out‑performance, or alpha, resides in small‑cap and mid‑cap stocks that are either under‑represented or absent in these benchmarks. He cites a comparative study by CRISIL that found that the top 10‑percent of equity managers by AUM consistently beat the Nifty 50 by an average of 1.5 % per annum over the last decade.

To illustrate, the article follows a link to a CRISIL research paper that charts the performance of active managers across various asset‑class segments. The data shows that active managers in the mid‑cap space, for instance, have outperformed the Nifty 50 by 2–3 % annually. Khemani argues that the indices’ heavy weighting toward large‑cap names and their slower rotation fail to capture the “high‑growth, high‑risk” opportunities that active managers chase.

3. Why Passive Strategy Is Not a Future‑Proof Bet

Khemani dissects several structural reasons why passive funds may not remain the dominant growth engine:

• Concentration Risk: The Nifty 50, for instance, includes 15 % of its weight on just the top five companies. This concentration means that a few large‑cap failures can drag down the entire index, whereas active managers can diversify beyond the benchmark.

• Limited Rebalancing Flexibility: Passive funds re‑balance only when the benchmark index changes, typically every six months or annually. Active funds can adjust positions in real time to capture market inefficiencies.

• Regulatory Hurdles: The article links to an SEBI notice that imposes higher compliance costs on large index‑fund providers. In contrast, small‑cap and mid‑cap mutual funds often have more relaxed regulatory reporting, giving active managers more room to maneuver.

• Investor Behaviour: Khemani points out that retail investors in India are becoming more “price‑sensitive.” With the proliferation of low‑cost ETFs, there is a fear that these investors will simply “follow the herd,” thereby amplifying market volatility when indices rally or slump.

4. The Active Manager’s Advantage

Active managers, according to Khemani, have a distinct advantage because they can incorporate qualitative factors that are invisible to pure price‑based index replication. The article references an interview with a prominent mid‑cap fund house where the portfolio manager explains how macro‑economic signals, sector‑specific growth, and corporate governance trends are integrated into portfolio construction.

A key insight comes from an analysis of the 2021‑2023 period, where active managers captured an average alpha of 1.8 % per annum over the Nifty 50. This figure, while not huge, is statistically significant and shows a consistent outperformance trend that aligns with Khemani’s thesis.

5. Implications for Retail and Institutional Investors

Khemani’s warning is not that passive investing is useless – it still offers liquidity, lower costs, and a convenient way to get broad market exposure. Instead, the message is clear: investors should look beyond the index if they seek sustained alpha.

For retail investors, the recommendation is to consider a hybrid strategy: allocate a core portion (around 60 %) to passive index funds and a smaller, tactical portion (around 30–40 %) to actively managed funds or even single‑stock positions in mid‑cap or small‑cap space. Institutional investors, on the other hand, should intensify their due diligence when selecting asset managers, focusing on track record, turnover ratios, and risk‑adjusted performance.

6. What’s Next for India’s Investment Landscape?

The article concludes by noting that SEBI is already exploring reforms to make the market more conducive for active management. The proposed “Active Asset Management Guidelines” aim to reduce transaction costs and improve transparency for active funds, which could level the playing field.

Khemani ends with a cautionary note: “Passive investing will continue to grow, but the next decade will be defined by who can capture alpha that lies outside the indices.” For investors who are willing to do the legwork, there are still abundant opportunities in India’s diverse and dynamic market.

In short, while passive index funds have democratized market access and offered a low‑friction way to participate in India’s growth story, the article from MoneyControl argues that they are not a silver bullet. The real value – and the “alpha” – resides outside the broad indices, in smaller, nimble, and more speculative segments of the market that active managers can exploit. As India’s capital markets mature, investors who stay flexible and mindful of these nuances are likely to reap the greatest rewards.