Graph 1:\u00a0The Rising AUM of Passive Funds<\/em><\/strong><\/p>\n\n\n\n Data as of August 31, 2022 But absolute numbers may not reflect an accurate picture. Thus, before we discuss the potential reasons for such a massive jump in the AUM of passive funds, let’s understand where they stand in relative terms (as a percentage of AUM of open-ended funds).<\/p>\n\n\n\n Chart 2:\u00a0Passive funds are gaining prominence…<\/em><\/strong><\/p>\n\n\n\n Data as of August 31, 2022 Graph 2 depicts that the AUM of passive funds<\/a> as a percentage of the total AUM of all open-ended funds has jumped from 7% in August 2019 to 15% in August 2022. That confirms that passive funds are on a song, gaining all the attention of Indian investors.<\/p>\n\n\n\n However, in the global context, they are still in an early stage of progress. For instance, passive funds account for nearly 16% of the total market cap of companies listed in the U.S. In India, the AUM of passive funds still forms only about 2% of India’s total listed market capitalisation.<\/p>\n\n\n\n Nonetheless, the rapid growth of passive funds-whether through Index Funds<\/a> or Exchange Traded Funds<\/a> (ETFs)-is a positive and an early indicator of maturing markets.<\/p>\n\n\n\n For those of you who aren’t aware of passive funds, they are a type of mutual fund that simply mimic their benchmark indices without any intention to generate alpha. That said, it still offers diversification through exposure to a range of securities across sectors within the respective index.<\/p>\n\n\n\n In other words, passive funds generate returns that are in line with their respective benchmark index at best but can’t outperform them under ideal conditions. This is because passive funds aren’t actively managed. The fund manager passively manages the portfolio by seeking to replicate the underlying benchmark, thereby reducing the fund manager’s involvement or any behavioural biases.<\/p>\n\n\n\n Further, the expense ratios<\/a> of passive funds are extremely competitive compared to active funds, where the day-to-day involvement of the fund manager in handling the scheme is high. Also, their risk quotient is better: they aren’t exposed to risks associated with being overweight or underweight in a particular sector\/theme\/security.<\/p>\n\n\n\n Passive funds come in different genres\u2014Index Funds, Exchange Traded Funds (ETFs), speciality-based index funds\/ETFs, and Fund-of-Funds investing in index funds\/ETFs.<\/p>\n\n\n\n Moreover, they can be distinguished by their target asset classes. For instance, gold ETFs<\/a> aim to track the movement of gold prices. Whereas an ETF based on the Nifty 50 will primarily align itself with the Nifty 50 index, and so on.<\/p>\n\n\n\n So why do investors prefer passive funds and settle for average performance rather than going with active funds, which hold the potential to outperform their benchmark index?<\/p>\n\n\n\n Many of you might conclude that the underperformance of active funds against their respective benchmarks could be the primary reason for investors to chase passive funds. Well, to an extent it’s true but not entirely.<\/p>\n\n\n\n The table below depicts, broadly, how various categories of mutual funds fared over various time periods. Barring large-cap funds<\/a>, all other categories have convincingly outpaced equity-oriented passive funds.<\/p>\n\n\n\n Table: Passive funds vs. active funds – how have they fared?<\/em><\/strong><\/p>\n\n\n\n![\"Graph\"](\"https:\/\/data.personalfn.com\/images\/Graph-1-The-Rising-AUM-of-Passive-Funds.jpg\")
<\/p>\n\n\n\n
(Source: AMFI, PersonalFN Research)\u00a0<\/p>\n\n\n\n![\"Graph\"](\"https:\/\/data.personalfn.com\/images\/Chart-2-Passive-funds-are-gaining-prominence.jpg\")
<\/p>\n\n\n\n
(Source: AMFI, PersonalFN Research)\u00a0<\/p>\n\n\n\n