Index business grows as investors flock to passive funds for returns

Index-based products rise to top as active fund managers fail to impress clients.

The business of creating and maintaining a stock market and other indices is growing as interest in passive funds grows.

Passive funds mimic returns of an underlying index. They have become popular as active fund managers who look to provide index-beating returns increasingly fail to deliver. An analysis of index business numbers shows a double-digit growth over the last two years.

The overall business has profits nearing Rs 100 crore in 2020-21 (FY21) compared to less than half that amount three years ago. The National Stock Exchange’s index segment profits grew 17.1 per cent in the 2020-21 financial year to Rs 96.5 crore. The BSE index business figures for the year aren’t immediately available. It has clocked an average of around Rs 2 crore in profits over the last three years, based on the index joint venture numbers from earlier annual reports.

The average net assets under management of index funds, gold and other exchange-traded funds was Rs 1.7 trillion in March 2020. This rose 80.4 per cent to Rs 3.1 trillion as of March 2021. This is faster than the growth in overall assets that the mutual fund industry managed. It rose 30.2 per cent to Rs Rs 32.2 trillion over the one-year period ending March 2021.

Few funds had beaten benchmarks around a year after the lockdown to control the Covid-19 pandemic in March 2020, showed an analysis of fund returns from mutual fund tracker Morningstar. Around 3.45 per cent of large-cap funds beat their index during that period, according to the Morningstar analysis. It was 8.7 per cent for small-cap funds. The mid-cap category did best. But even there, 76 per cent of funds underperformed their benchmark indices.

Passive funds typically have lower expenses than actively managed funds. This helps add to returns over the long term for such funds compared to those with active fund managers which charge investors more for fund management.

There is enough room for both passive and active fund managers in India, according to a February 2021 Equity Research report from the Jefferies Group. While exchange trade funds may grow from their current base, India’s stage of market development does not exclude active fund management, according to equity analysts Abhishek Saraf and Prakhar Sharma.

“We believe India is still at early stages of equity penetration which does not lend itself to higher level of ETF participation,” they said.

Mutual funds manage money equivalent of around 12 per cent of gross domestic product in India. The elevated share of passively managed exchange traded funds is higher in countries like the United States of America and Canada where penetration is higher. Canada’s mutual fund assets are 67 per cent of its GDP. The number for the USA is 120 per cent, noted the report.

A number of mutual fund houses continue to launch passively managed funds. Recent filings include the Axis Nifty 50 Index Fund, the Aditya Birla Sun Life Financial Services ETF, the Navi Nifty Index Fund and the ICICI Prudential Smallcap Index Fund.