After years of hiatus, what triggered the takeoff of passive investments in India

Calendar 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 Covid pandemic, passive investments broke new ground -- both in terms of investor interest and asset under management. At the start of 2020 (January), the average assets under management for index funds and ETFs, including gold ETFs, stood at Rs 8,082 crore and Rs 1,84,534 crore, respectively. By October 2020, asset under each of these segments ballooned to Rs 13,017 crore and Rs 2,27,332 crore, respectively, registering a growth of 61% and 23%. This happened at a time when passive investing was at a very nascent stage in India.

Rise of the ETFs
An exchange-traded fund (ETF) is a basket of securities that tracks a particular index and trades on the exchanges just like a stock. It can be bought and sold at any point of time throughout the trading day. The first ETF in India was a Nifty50-based ETF launched in December, 2001. So, by no means ETF is a new offering in the financial landscape. However, what has changed is the widespread acceptance the product among investors today. It was only in August 2020 that ETF assets tracking Nifty50 crossed Rs 1 lakh crore.

Even though assets under management in ETFs have not been very significant compared with that in equity funds, the annual growth rate that ETFs enjoy has been remarkable. On a five-year basis, while equity mutual funds grew at 20 per cent per annum, ETFs have grown at 89 per cent, the caveat here is a lower base.

Despite this stupendous growth, total AUM of ETFs along with index funds still comprises less than 10 per cent of the overall mutual fund AUM. In the US, passive funds account for more than 50 per cent of the overall mutual fund industry AUM.

Options available
Across asset classes, the Indian mutual fund industry offered 96 ETFs as of October 2020, of which 75 are equity-based with assets of over Rs 1.75 lakh crore. That number stood at Rs 200 crore across 57 products five years back and 26 products with assets less than Rs 100 crore a decade back. Among the equity offerings, largecap ETFs are the most widely available products across fund houses. Next comes gold ETF, with 11 schemes and an asset universe of Rs 13,862 crore.

Aiding Factors
1. Govt disinvestment drive through ETF
In 2014, the Indian government brought in ETFs for subsequent disinvestment through that route. This announcement put the spotlight on ETFs. So far the disinvestment program has been pursued through two ETFs, namely the Central Public Sector Enterprises (CPSE) ETF that tracks the Nifty CPSE Index made up of 11 PSU stocks, and the BHARAT 22 ETF, which tracks the S&P BSE Bharat 22 Index comprising 22 companies drawn from 11 different sectors.

2. EPFO investment
Close on the heels of the divestment program, another development literally set the ball rolling for ETFs: retirement fund body EPFO said it would be investing a portion of its corpus in equities through ETFs. Since August 2015, EPFO has been investing largely in ETFs based on Nifty50 and S&P BSE Sensex along with CPSE and Bharat 22 indices. As of September 2019, total EPFO investment in ETFs stood at Rs 86,966 crore.

3. Improved investor awareness
Over the past few years, fund houses along with the media and other partners have been actively pushing the case of passive investments, be it plain vanilla products such as index ETF or thematic ETF, or evolved products such as smart-beta ETFs. This has led to improved understanding among the masses about the possibility of diversifying the portfolio with various passive index/ETF products.

4. Resurgence of active v/s passive debate
The debate over active v/s passive investing has been gaining momentum, as several of the active funds are struggling to beat their respective benchmark(s). This is especially at a time when the benchmark indices have been growing from strength to strength, leading several investors to jump ship to low-cost options such as passive funds.

5. Use of innovative platforms
Apart from fund houses, several online investment platforms have been promoting ETFs as an effective and low-cost alternative to meet one’s long-term financial goals. Their innovative communication coupled with sustained push thus far seems to have hit the nerve, especially among young investors who are looking to invest on the go.

The road ahead
ETFs are still largely being looked at as an institutional product. The road ahead for ETFs in India will be similar to that of global ones, where passive products progressed from plain vanilla schemes replicating the benchmark indices to factor-based (single or multi-factor) and geographically-focussed offerings. It is very likely that we are in the early days of the proliferation of smart-beta ETFs in India. As the understanding of sustainable investing improves in India, we could see ESG-based ETFs as well to meet the needs of a conscious investors.

Having said that, much needs to be done in terms of improving product awareness among retail investors. An informed investor is an empowered investor, and hence, it is important to improve investor awareness about passive products.

(Chintan Haria is Head of Product Development & Strategy at ICICI Prudential AMC. Views are his own)