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Indian Investor Warns Against Passive Investing Trend

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  Published in Stocks and Investing on Sunday, December 28th 2025 at 8:21 GMT by moneycontrol.com

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The End of Passive Investing in India? Veteran Investor Vikas Khemani Sounds an Alarm

For years, passive investing – primarily through index funds and ETFs – has enjoyed surging popularity globally, and India was no exception. The promise of low costs, broad market exposure, and effortless diversification made it a seemingly attractive option for both novice and experienced investors. However, a prominent Indian investor is now questioning the long-term viability of this strategy in the Indian context. Vikas Khemani, Managing Director of Carnelian Capital, a well-respected stock picking firm, has argued that there's “no case” for passive investing in India for at least the next decade, asserting that opportunities for generating "alpha" – outperformance relative to market benchmarks – lie firmly outside of indices.

Khemani’s argument, detailed in a recent interview with Moneycontrol, challenges the prevailing narrative surrounding passive investing and could have significant implications for how Indian investors approach their portfolios. He isn't dismissing passive strategies entirely; rather, he believes they are fundamentally less suited to the unique dynamics of the Indian market compared to active management.

Understanding Passive vs. Active Investing

Before delving into Khemani’s reasoning, it’s crucial to understand the difference between passive and active investing. Passive investing aims to replicate the performance of a specific index, like the Nifty 50 (India's benchmark for the top 50 companies) or the Sensex. Index funds and ETFs are common vehicles for this strategy. They offer low expense ratios because they don’t require extensive research or stock picking – the fund simply buys the stocks that make up the index in roughly the same proportions.

Active investing, on the other hand, involves actively selecting investments with the goal of outperforming a benchmark. Active managers conduct research, analyze company financials, and attempt to identify undervalued opportunities or anticipate market trends. This approach typically carries higher expense ratios due to the cost of this analysis and decision-making.

Why Passive Investing Works (and Doesn't) Globally

The global rise of passive investing is largely attributable to its low costs and consistent performance relative to benchmarks, particularly during periods of overall market growth. In developed markets like the US, where index composition changes are relatively infrequent and the efficiency of information flow is high, it can be difficult for active managers to consistently beat the market after accounting for fees.

However, Khemani argues that these conditions don't hold true in India. The Indian stock market, while maturing rapidly, still exhibits characteristics that favor active management. These include:

• Index Concentration: The Nifty 50 and Sensex are heavily concentrated in a relatively small number of large-cap companies, particularly from the financial and IT sectors. This concentration means that the performance of these indices is largely driven by the performance of just a few stocks. If those dominant players stumble, the entire index suffers.
• Lower Market Efficiency: Information dissemination and analysis are less efficient in India compared to developed markets. Opportunities for identifying undervalued companies often arise due to information asymmetry or misinterpretations of data. Active managers with strong research capabilities can exploit these inefficiencies.
• Structural Growth & Disruption: The Indian economy is undergoing rapid structural changes, driven by factors like digitalization, government reforms (like GST), and evolving consumer preferences. These shifts create opportunities for smaller companies to disrupt established players and experience significant growth – the kind of growth rarely captured in passive indices which are dominated by larger, more established firms.
• Small & Mid-Cap Potential: Khemani specifically highlights the potential within small and mid-cap companies. These segments often fly under the radar of large institutional investors who dominate index fund holdings, creating opportunities for active managers to find hidden gems with significant growth prospects. The recent surge in Indian small-cap indices demonstrates this potential, although it also carries increased risk.

Khemani’s Specific Rationale and Recommendations

Khemani isn't suggesting that all passive investing is inherently bad. He acknowledges its role as a part of a diversified portfolio. However, he believes the core allocation for Indian investors should shift towards active strategies focused on identifying companies with strong fundamentals, sustainable competitive advantages, and growth potential. Specifically, he recommends:

• Prioritizing Active Management: Investors should allocate a significant portion of their portfolios to actively managed funds or individual stock picking (if they have the expertise).
• Focusing on Fundamentals: Emphasize bottom-up research – analyzing company financials, management quality, and industry dynamics.
• Exploring Small & Mid-Caps: Consider allocating capital to small and mid-cap focused funds, but with careful risk assessment due to increased volatility.
• Being Selective: Not all active managers are created equal. Thoroughly vet the manager's track record, investment philosophy, and experience before investing.

Conclusion: A Shift in Perspective?

Vikas Khemani’s perspective represents a significant challenge to the prevailing wisdom of passive investing in India. While low costs remain attractive, his argument highlights that the Indian market's unique characteristics – its concentration, inefficiencies, growth potential, and vibrant small/mid-cap landscape – create opportunities for skilled active managers to generate substantial alpha. Whether Khemani’s view will prompt a widespread reevaluation of investment strategies remains to be seen, but it undoubtedly raises important questions about the suitability of passive investing in a rapidly evolving Indian market. Investors should carefully consider his arguments and reassess their portfolio allocations accordingly.

Disclaimer: I am an AI chatbot and cannot provide financial advice. This article is for informational purposes only and should not be considered investment recommendations. Always consult with a qualified financial advisor before making any investment decisions.