Passive investment has become quite popular in India over the last few years, be it through index funds or exchange traded funds (ETFs). As of October 2020, there are a total of 96 ETFs of which 75 schemes are equity-based with assets of over Rs 1.75 lakh crore. Five years ago, the assets were around Rs 200 crore across 57 products, and a decade back there were only 26 products with assets less than Rs 100 crore. Since passive funds usually have lower costs associated with them, they often result in higher returns. But do they always beat actively-managed funds? Should you invest in them? In a conversation with Outlook Money, Chintan Haria, Head (Product Development and Strategy), ICICI Prudential AMC, talks about all you need to know about index funds.

Passive investment has been gaining prominence over the last few years. What is your view on passive investment?

The year 2020 has been a landmark year for passively managed products in India, be it Index funds or ETFs. At a time when the market was reeling under the effects of the spread of the pandemic, passive investments broke new ground both in terms of investor interest and assets under management. This is despite passive investing being at a nascent stage in India.

We believe ETFs in India, though currently in a nascent stage, hold encouraging prospects. The journey is likely to be akin to developed global markets, where passive products progressed from plain vanilla products replicating benchmark indices to factor-based (single or multi-factor) and geographically based offerings. We are likely in the early days of the proliferation of smart beta ETFs in India.

As of today, a significant portion of the assets under management is from pension funds and institutions. However, over the past two years, the number of retail participants in the ETF universe has improved significantly, which is an encouraging sign. At a time when retail investors are increasingly looking at investing into direct equities, ETFs could prove to be a better alternative to take exposure to equities.

Do you think that passive investment strategies are as successful in the Indian market as they are in more developed Western markets?

It would be inaccurate to draw the comparison with developed western markets as the market dynamics for passive products there are very different. In western markets, ETFs as a concept is a mature one unlike India. However, there are plenty of positive signs here for the ETF market, the recent one being increased investor interest and the ETF assets under management crossing the Rs 2 lakh crore mark.

How much of an allocation one must have to passive funds?

The allocation to passive products in a portfolio will depend on a variety of factors such as risk appetite, liquidity requirements and investment objective to name a few. The extent of exposure can be best decided in consultation with a financial advisor. However, for allocation to gold, one can consider Gold ETFs as it is a convenient and easy way to take exposure to the yellow metal.

Many say that in markets like India, there is a lot of scope to pick and choose alphas and passive funds may not be able to deliver comparable returns to those that a good fund manager can deliver to you. What is your view on this?

In a developing market like India, there is always room for generating alpha from actively managed strategies. At the same time, some investors are looking to take exposure to equity markets passively by tapping into returns akin to that of the underlying index. Historically, both of these strategies have helped investors to clock in gains from their investments. With the advent of smart beta ETFs, there comes an element of factor based selection, which is unlike the plain vanilla ETFs. For example: ICICI Pru Low Vol 30 ETF, which is a smart beta ETF is one of the ways of investing in a fund with a superior risk adjusted return due to its focus on 30 stocks with lower volatility within the large cap universe.

How can small investors invest in passive funds? What are some of the things they should keep in mind?

An ETF is a basket of securities (stocks, bonds, gold bars, etc) tracking a specific index. It is imperative to have a demat account when it comes to purchasing or selling ETFs. One can purchase/sell ETFs at any point of the trading day just like a stock. Moreover, ETFs are transparent (index constituents are known) and cost efficient. Following are some of the basis one has to remember when investing in an ETF:

• For equity ETFs, one can purchase as low as a single unit, at per unit cost. There is no minimum investment limit.

• Bond ETFs - Minimum investment is of Rs 1,000 and in multiples of Rs 1,000 thereafter

• Gold ETFs - Minimum investment in gold ETF is 1 unit