A few years back on highlighting the benefits of passive investing or index investing; there was skepticism on its ability to get a foothold in Indian financial markets. How the tides have turned! Now, not only do we have the skeptics accepting its value, but also propagating the concept. Undoubtedly, India is still largely an active market within the scope of generating alpha on average market returns. However, market trends and statistics are now creating awareness of this alternative investment strategy.
To better understand passive or index-based investing, one must first understand what an index is. An index is a basket of securities designed to represent a concept, asset class, geography, or strategy. Indices are designed with clear rules that are defined in a transparent methodology that forms the guidelines for the stocks that enter or exit the index during periodic reviews. These periodic reviews are known as rebalancing and are critical for the index to remain relevant during changing market conditions. For example, if the index methodology has a rule that states only companies with consistent quarterly profits can be part of the index, and one of the companies does not meet the rule during the index’s quarterly rebalancing or review, the company will then be dropped from the index and the next company in line that qualifies will enter the index.
A transparent methodology ensures there is no bias in the selection of stocks and that the index follows the design it was created for. Independent index providers add further neutrality to the index creation process.
Additional benefits of the passive style are:
- Access to a diversified basket, thereby avoiding concentration risk;
- Rather than a single stock, single sector, or single asset class focus to a broader choice of a basket of stocks via an index; and
- Lower costs, as index-based investing does away with the additional costs of active research trading, management charges, etc.
In India, some of the headline indices are the S&P BSE SENSEX, S&P BSE 100, and S&P BSE 500. Statistics have revealed that in certain segments, such as large caps, active strategies have been underperforming benchmark indices. This means that the indices are providing higher returns compared with certain large-cap active funds.[i]
As of Dec. 31, 2018, the amount of assets in exchange-traded funds in India was valued at approximately INR 11,236 crores, a 44% year-over-year growth, which was lower than the 115% and 126% growth rates seen in 2016 and 2017, respectively.[ii]
|Exhibit 1: Assets in Exchange-Traded Funds in India (INR Million)|
|ASSET CLASS FOCUS||DEC. 31, 2013||DEC. 31, 2014||DEC. 31, 2015||DEC. 30, 2016||DEC. 29, 2017||DEC. 31, 2018|
Source: Bloomberg. Data as of Dec. 31, 2018. Past performance is no guarantee of future results. Table is provided for illustrative purposes.
While the debate of active versus passive is ongoing, the belief that both styles can be encompassed to achieve various investment objectives is changing the horizon in Indian financial markets. Passive investing is not only here to stay but to grow.
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[ii] Source: Bloomberg