Passive inflows increasing but with a recency bias

October'19 Mutual fund data threw an interesting statistic - Index funds and ETFs saw inflow of 6000 crore, almost equal to net inflows from other 'active' equity oriented schemes. The shift from 'passive' to 'active' was evident. In last 5 years, AUM of passive funds have increased from 3500 cr to 185000 cr. Passive funds are still 6% as compared to 35% in the US. So these are still early days in passive investing in India.

Earlier Posts on Active vs Passive : Approaches to investing

Let's see some factors which has led to higher index flows in the recent months:

Passive Inflows have a recency bias

Returns of Nifty is concentrated in few stocks - HUL, HDFC Bank, RIL, TCS, and ICICIBNK over the last 1 year. Active mutual funds cannot have concentrated portfolio as it goes against the basic principle of diversification. Hence, the active funds have under-performed as compared to Nifty. In 2018, active funds had given negative returns while passive funds had yielded +2.3%. In 2019, active funds earned a median return of +5.3% against +9.3% for the passive funds. Clearly, it is the recent performance which is encouraging more passive flows.

SEBI classification of MF categories hit Alpha

In 2018, SEBI classified all MFs to have only 1 category scheme only. This put limits to buying any stock outside the top 500 stocks. A large cap fund needs to have 85% in top 100 stocks. Similarly, a mid cap fund needs to have 75% of allocation from stocks between 101-250 category. This has hit the Alpha in the past couple of years in the active category of funds. It is to be noted that this corrected the rampant practice of showing a larger alpha in a category not suited as per risk appetite of the investor. Those who are not aware of this are looking at returns of active funds vs passive funds and deciding to put money in the latter.

Cheaper costs in Passive schemes

A 'direct' active scheme median TER is around 1.6% while a 'regular' active large cap scheme is around 2.4%. As compared to this, a direct passive scheme is around 0.1%-0.4% only. This difference in costs make the eventual return of passive and active fund seems significant. In bad markets like last two years, investors have woken up to this and hence, pushing more money in the passive products.

The author may have positions in the stocks as mentioned in the article above, please assume us to be biased. This is not a recommendation to buy or sell securities. This is purely information about the company mentioned. Equity investing contain risks and please consult your financial adviser for any buy and sell securities!


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