Fire-and-forget: Retail investors starting to see virtues of passive funds

The rally in precious metals may have triggered a change in the attitude of India’s retail investors. In September, net account addition in schemes of passive mutual funds (MFs) overtook those in active equity funds for the very first time. This movement into passive funds was driven largely by investors getting into gold and silver exchange-traded funds (ETFs). But while gold and silver may have been the main triggers, this does mark a change in attitude. Passive schemes — including index funds and ETFs — recorded 1.2 million new accounts registered during the month. When fund-of-fund (FoF) schemes are included, the addition in passive assets rises to 2.1 million. Meanwhile, active equity schemes saw 1.4 million new accounts opened in September.

 

While India’s households have invested heavily in equity mutual funds over the past five years, most investors have favoured active schemes. Higher distributor commission on active products has led to intermediaries steering clients to such schemes. Active equity funds currently account for 175 million active accounts, or about 70 per cent of the 252 million MF folios. Gold and silver ETFs alone added a record one million accounts in September. Although the data on gold and silver FoFs is not yet available, metal FoFs are believed to have drawn a record number of new investors. Gold ETFs drew ₹8,151 crore in September, up from ₹2,190 crore in the previous month. Silver ETF inflows trebled to ₹5,342 crore. ETFs, which closely track the price of underlying assets, are convenient ways to invest in precious metals, since they are paperless digital assets in contrast to bulky physical ones.

 

It is significant that many investors also entered passive equity-index instruments in September and it may be a sign that retail investors are maturing. In most large economies the vast majority of retail investments are via mutual funds and most of that is also invested via index funds and ETFs. The concept is simple. The investor holds a broad basket of stocks. For example, a Nifty index fund holds all 50 constituent stocks of the Nifty in the same weighting as the index itself. There is no agency for the fund manager beyond ensuring the weightings track as close as possible to the benchmark. The returns closely mirror the index return and index funds have low mandated expense ratios since a great deal of trading is not required. An ETF is very similar — one difference is that ETF units are traded on stock exchanges like shares, whereas index-fund units are bought or redeemed directly from the fund house.

 

The concept of the index fund was popularised by mavens such as John Bogle of the Vanguard group. The basic reasoning is that in an efficient market, it is hard for an active investor to consistently outperform a broad, well-diversified index. Over six decades of data across multiple geographies bears this out. Hence, retail investors may as well save themselves the pain (and higher expenses and higher risks) of picking an active equity fund since a passive index will probably give better returns anyway. While the leading Indian fund houses do run some active schemes that outperform benchmark indices, index funds offer very decent returns with lower levels of risk. It is possible that experienced Indian investors are starting to appreciate the virtues of the passive, fire-and-forget approach.