Across 5-year and 10-year periods, the majority of actively managed large-cap equity funds underperformed S&P BSE 100 Index
Alpha generation in India is becoming a challenge and so industry experts are promoting passive funds or exchange-traded funds.
Exchange-Traded Funds are essentially index funds that are listed and traded on exchanges like stocks. An ETF is a basket of stocks that reflects the composition of an Index such as S&P CNX Nifty or BSE Sensex.
The ETFs trading value is based on the net asset value of the underlying stocks that it represents. Think of it as a Mutual Fund that you can buy and sell in real-time at a price that changes throughout the day.
The intermittent bouts of volatility in the domestic equity market have led to underperformance of several active equity funds offered by mutual fund houses.
“Alpha generation in India is becoming a challenge. There is no liquidity in active funds and you cannot trade is like a stock, tracking error is also low. Consistently delivering above benchmark returns in active funds is not easy given churn in the portfolio and higher costs, thus market dynamics is helping ETFs,” said Vishal Jain, Head ETF, Reliance Nippon Life Asset Management Ltd.
Reason for most active funds underperforming is two-fold. Multi-cap funds and mid n small-cap funds have fallen much more than Nifty in 2018 and 2019. Among large caps, certain sectors like metals and infrastructure have taken heavy beating making to diversify large-cap underperforming.
“Investment managers are not beating the market. The market is beating them,” said Koel Ghosh, Head- South Asia, S&P Dow Jones Indices.
According to SPIVA (S&P Indices Versus Active Funds) Scorecard, over the last one-year period, the S&P BSE 100 returned merely 2.62 percent and 92 percent of large-cap equity funds underperformed the benchmark.
In fact, across 5-year and 10-year period too, the majority of actively managed large-cap equity funds underperformed the S&P BSE 100 Index.
WHY ETFs
Five years ago, Indian passive product AUM was largely concentrated around Gold ETFs.
But changing regulations, evolving market microstructure, and Indian government initiatives have led to the rapid growth of passive investments.
ETF experts also said that although passive investing is still at a nascent stage it is experiencing notable momentum. One of the major reason for the success of ETFs is government initiatives.
“Government initiatives are helping ETFs grow. EPFO (Employees’ Provident Fund Organisation) invests the incremental surplus into equity ETFs. Also, DIPAM (Department of Investment and Public Asset Management) does its disinvestments via ETFs whether it’s CPSE ETF or Bharat 22 ETF,” said Ghosh.
As per S&P Dow Jones data, DIPAM has raised around Rs 340 bln via multiple tranches through various ETFs since 2013. AMFI data indicates the assets under management (AUM) of passively managed funds have crossed the Rs 1 lakh crore mark.
Another driver is the push from the Securities and Exchange Board of India to drive costs down for investors and increase transparency.
“Approximating the difference between the costs of active funds (165 bps) versus passive products (53.5 bps), an Indian investor can potentially save upwards of 100 basis points investing via passive route,” Ghosh said.
To illustrate the importance of costs, we will consider the total expense ratio (TER) for Indian equity mutual funds. The TERs for active equity funds are in the range of 105 bps to 225 bps.
In addition, the TER for index funds and ETF is restricted to 1 percent though, in reality, the expense ratios for many passive ETF options are much lower, dropping to as low as 7 bps for large-cap ETFs based on the S&P BSE Sensex.
Passive Challenging Active
Both globally and locally, statistics prove that benchmarks are outperforming active funds, as per SPIVA report.
As markets efficiencies grow, experts say that it will become challenging for active funds to regularly beat the benchmarks, hence passive investing is here to stay.
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