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All about Passive Funds and Passive Investing

Curious about passive funds? We have it decoded for you!!

Passive investing is the most simplest and basic form of investing. It may also be called rule based investing where there is hardly any human intervention or constant shuffling. Most passive funds in India are based on broad market indices which simply puts together a bunch of companies based on their marketcap size and then weight them using Free float marketcap.

Passive and active mutual funds in investing

While passive investing is known for its simplicity, we are guilty of making the concept a bit complex. We have been emulating our western counterparts on passives by talking about falling alpha in active, which is too complex to understand for an average investor.

In India, most investors come into equities to earn returns that are better than FD, Gold and real estate. The 3 main asset classes, which Indians trust completely and have insanely high amount of exposure and trust.

Any average investor coming to an equity Mutual Fund is obsessed only about absolute returns. He/she rarely cares about relative returns.
Ask any advisor and they would have never heard an investor saying “my fund gave me x% higher return than its benchmark” we usually hear the investor saying “my fund gave me x% returns”!!!

The alpha narrative is complex, because to make investors believe in passive investing – we are first creating a belief that active funds may be bad and high risky (which ain’t false again) but this is something which we really wouldn’t know to be true or not in coming time. Even if it happens (i.e. alpha diminishes in active funds) this narrative around alpha is hardly useful for investors who have never invested in equities. Their expectations are not alpha, and today’s market is flooded with such folks!!!!

When we talk about alpha and low cost as the only benefit of passive investing, we restrict our view to only those people who understand the language of the markets. Who may already be investing in equities. They might care about these numbers and ratios, but an average investor does not!

Passive investing narrative should be simple.
It should solve the most basic problems for new investors.
Choosing a right fund is often a lengthy process, without support from an expert. Index funds on the contrary are simpler and a safer choice to make for a such new investors.

Choosing a right fund starts with studying style, performance across cycles, risks, absolute returns, comparative returns etc and continues with reviewing and tracking the fund performance consistently. This is a difficult task for most of the new investors .
Hence they should start with passives and later explore active for style diversification.

In a recently concluded poll by Grazing Minds on Linkedin which we did recently, most people voted for hassle free investing and simplicity over costs when asked about reason to invest in index funds.

We think a better way to describe passive funds in India is around simplicity, ease to choose and track, along with other benefits like low cost and market linked returns.

Today, no doubt index funds might be doing better than some active funds, but there are some active funds too which are doing better than index funds. So the only important reason to invest in index funds may not be alpha, but much more than that. With millions of newbies coming to equities first time, it becomes imperative to highlight things that are important and useful to them. Most people struggle in finding a good fund and still want to do it themselves.

Passive funds are great solution for such DIY investors.

People who already have active funds in their portfolio, for them – passive funds can compliment their existing portfolio very well. It may even reduce some risks of underperformance that may come through in an active fund in short term due to different investing style.There is great potential for passives in India, provided it is packed in a right box that is suitable for investors. We think the phase where people will invest in passive for its simplicity lies ahead of a phase where they will invest because active is not generating alpha.

Although you may have been getting your dose of gyaan from your MF house or from #MFSahi Hai ads, hope we too are able to clear out some curiousity around funds – active and passive!!

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