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November 29, 2017

Consider passive investing for creating wealth in long term

Passive investing is hugely popular in developed markets because of its low cost. For instance, exchange-tradedfunds (ETF) accounted for 14% of the total asset management industry in the US while the global average was nearly9% in Q2 2017, according to the International Investment Funds Association (IIFA). Back home in India, passiveinvesting is still an emerging concept and has a share of just 3% of all mutual fund assets. If India is to follow moremature markets such as the US, passive investing has a long way to go.

The Employees' Provident Fund Organisation’s (EPFO’s) decision to enter the equity market via ETFs, which follow passive investing, has, however,given a strong push to the category as seen in growth in the assets under management (AUM) of these funds. The central government has also chosenthe ETF route rather than traditional routes such as initial public offering (IPO), further public offering (FPO) or offer for sale (OFS) to divest its stake inpublic sector companies. All these developments are expected to encourage and popularise the concept of passive investing among Indian investors,especially since it comes with a host of advantages, as detailed below.


What can investors derive from passively managed funds?


Simple structure and variety: Domestic mutual funds offer index funds and ETFs under the umbrella of passive funds. As both types of funds mimic theperformance of an index, they follow a simple structure by investing in stocks in the same weightages as that of their chosen index. However, unlike anindex fund, an ETF is listed and traded on a stock exchange like equity shares. So an investor can buy and sell an ETF through a stock broker at any timeduring trading hours with its price changing dynamically based on not only the underlying value of its portfolio but also on its demand and supply. Anindex fund, on the other hand, can be bought and sold at its net asset value (NAV), which is based on the underlying value of its portfolio similar to othermutual funds. ETFs also offer investors the choice of spreading their investments across asset classes such as gold, money market and gilt ETFs.Within equities, too, an investor can have the option to invest in global equity and thematic ETFs. Currently, there are 21 index funds and 68 ETFs(including equity, gold, money market and gilt) available to investors in India.


No scope of bets going wrong: The difference between active and passive investing is that the former is designed to generate alpha over the benchmarkby actively investing in stocks and sectors. In doing so, there is a fair chance that a fund manager’s stock selection may go wrong and underperform itsbenchmark. On the other hand, passively managed funds, which track and replicate an index, can be a good option for investors who are satisfied withearning market returns.