Mutual funds offer lower costs as competition rises in passive space

Edelweiss MF latest to join bandwagon after cutting Nifty50 TER to 0.05%

Competition is heating up in the passive investment space with mutual funds (MF) striving to offer the lowest-cost index funds and exchange traded funds (ETFs).

Edelweiss MF on Wednesday announced sharp cuts in expenses charged by its equity index funds with the total expense ratio (TER) of all domestic equity index funds brought down to the lowest in their respective categories.

The TER of Edelweiss Nifty50 index fund has been reduced to 0.05 per cent, a fifth of the earlier 0.25 per cent. Sharp cuts in TERs have also been announced for its other index fund offerings, namely Nifty Next50, Nifty Midcap 150 Momentum 50, Nifty Smallcap 250, Nifty LargeMidcap 250 and Nifty 100 Quality 30.

A lower expense ratio helps passive funds deliver higher returns to investors, while also scoring better on the 'tracking error' metric.

"Lower expense ratios enhance tracking precision, keeping passive funds closer to their benchmark performance, thus providing investors with optimal returns at minimised costs," said Varun Sanan, head, passive business, Edelweiss Asset Management Company (AMC).

The cuts by Edelweiss MF come soon after most of the bigger players in the ETF space announced sharp reductions in the expense ratios of their Nifty50 and Sensex ETFs. Nippon India and ICICI Prudential were the first to announce a lower TER for the two ETF offerings in April. UTI MF and SBI MF followed suit.

As a result, the TERs have come down to 0.03-0.05 per cent for top Nifty50 and Sensex ETFs from 0.05-0.07 per cent earlier.

As all passive funds in a particular category deliver similar returns, cost becomes a key metric for fund selection and hence a major driver for inflows. Over the years, MFs have brought down the expenses in the popular passive offerings. As a result, the average cost of index funds has tread downwards even as there have several passive fund launches in high TER categories like thematic and international.

Passive funds, especially those tracking the large-cap indices -- Nifty50 and Sensex -- have gained prominence in recent years amid a rise in underperformance in large-cap schemes. The other major draw has been the widening range of offerings on the passive side.

During the two-year period (2020-21 financial year or FY21 to FY23), the assets under management (AUM) of index funds grew eight-fold to ~1.4 trillion, while the ETF assets surged 1.7 times to ~4.8 trillion. However, the retail holding in the total passive fund assets remains low. According to a Motilal Oswal Financial Services report, institutions owned over 91 per cent of the total ETF AUM at the end of FY23.

"The share of ETFs in retail total AUM is a meagre 2 per cent. This is because the Indian retail MF industry is highly dependent on the push model, wherein mutual fund distributors play an integral part in distribution. With commissions to distributors on equity schemes being much higher, the preference for distributing ETFs is much lower," the report noted.