Passive fund traction steady in February 2024

12 Mar 2024 , 12:14 PM

What triggered the growth of Passive story in India?

To understand the passive story as it stands today, one needs to take a perspective view and look back at how it evolved over the 4 years since the pandemic. Post the pandemic, there were several reasons for the rapid rise of passive funds in India. Here are a few key drivers of the growth of passive funds in recent years.

• The mutual funds (and especially the large cap equity funds) were struggling to beat the index on a consistent basis. With high costs and uncertainty over whether active funds could outperform the indices, there was a natural tendence among investors to prefer the passive funds like index funds and index ETFs.
• Costs of passive funds fell further. Index funds and index ETFs were always cheaper than active funds in terms of the total expense ratio (TER). However, with the markets getting increasingly competitive, the active funds struggled to make a difference and that is when the lower costs of passive funds began to have magnified value.
• Kurtosis was the other big problem that mutual fund managers were facing. In the last 3 years, you find returns concentrated in a handful of stocks. This created a problem for mutual funds as they cannot hold more than 10% in a single company. This limited their ability to expose to a single stock, and in the process these funds lost out on returns.
• The other reason for the growth of passive funds was the choice available and with the increase in the range of options, investors gravitated towards these passive funds. In addition, the index ETFs emerged as a very simple and convenient product that could bought and sold with your existing trading account and held in demat account.
• Finally, passive funds became an excellent tool for asset reallocation. For example, an investor who was overexposed to debt, could rectify the imbalance by just buying into an equity index fund. This is a much simpler way to diversify and also to reallocate the portfolio by adopting a passive portfolio.

At the end of the day, the proof of the pudding lies in the eating. Investors get a well-diversified portfolio by buying a passive index fund or index ETF. If you go by Sensex returns over the last 40 years, index returns can be very enticing even on CAGR basis over long run. Let us now turn to how the passive fund folios grew in February 2024.

Passive fund folio growth: February 2024 over April 2023

We can look at the growth of passive fund in India; either in terms of folios or AUM. Let us first look at growth in folios first. There are 13 categories of passive funds as identified by AMFI, although we did drop “Other domestic ETFs”, category due to zero folios. The table below captures actual folio numbers and the folio growth of the remaining 12 categories of passive funds with active folios as of February 2024 over April 2023. Why did we choose this period. This is the period for which data is available and while it may be slightly short, the credibility of such comparisons will gradually build over time. Investor folios are a good proxy for retail intensity.

Passive Mutual Fund Schemes (Folios)	Folios Feb-24 (in Numbers)	Folios Apr-23 (in Numbers)	Growth (%)
Silver ETF	2,06,893	75,891	172.62%
Fund of funds investing overseas in Passive Funds	7,78,820	3,74,286	108.08%
Equity oriented Index Funds (Domestic Index Funds)	67,62,068	35,59,102	89.99%
Equity oriented ETFs (International ETFs)	4,03,951	3,21,986	25.46%
Other Index Funds	65,233	57,565	13.32%
Equity oriented ETFs (Domestic ETFs)	1,08,28,911	98,45,185	9.99%
Income/Debt Oriented ETFs	20,24,514	18,67,689	8.40%
Gold ETF	50,23,955	47,12,199	6.62%
Equity oriented Index Funds (International Index Funds)	2,31,734	2,38,189	-2.71%
Income/Debt Oriented Index Funds (Other than TMIF)	15,175	15,613	-2.81%
Income/Debt Oriented Index Funds (TMIF)	1,39,834	1,49,954	-6.75%
Fund of funds investing overseas in Active Funds	7,73,161	9,41,061	-17.84%
Total of Passive Schemes	2,72,54,249	2,21,58,720	23.00%

Data Source: AMFI (TMIF is target maturity index funds)

The above table compares the folios at the end of February 2024 with the folios at the end of April 2023. Here is what we read from the data.

• Passive fund folios grew by 23% between April 2023 and February 2024. That is a lot of investor intensity in last 10 months. The total folios of passive funds stand at nearly 272.54 lakhs (264.12 Lakhs las month), which is 15.65% of overall mutual fund folios.
• Which is the specific category of passive fund that led the growth. The leader was silver ETFs, a recent addition, which saw folios growing by 172.62% over April 2023. That is fantastic growth in 10 months, but it comes on a fairly low and recent base.
• The other two categories of fund that saw good traction were FOFs investing in passive global funds that has grown folios by 108.08% over April 2023 and equity oriented domestic index funds that showed growth of 89.99% over April 2023. Equity oriented international ETFs also grew 25.46% in the same period.
• Which were the laggards in this folio growth list? On the downside, the FOFs investing in overseas active funds continued to see a sharp fall in folios by -17.84% while the income oriented TMIFs and the income funds (other than TMIFs) saw contraction of -6.75% and -2.81% respectively over April 2023. Passive funds are surely picking up steam.

As of February 2024, out of the 12 categories of passive funds with active folios, 8 categories saw accretion in folios over April 2023 while 4 categories saw contraction in folios.

How AUM of passive index funds shifted in February 2024

The table below captures the AUM of the 12 categories of passive funds with active folios as of the close of February 2024. Unlike folios, AUM is a mix of fresh flows and value accretion with rise in the market. The AUM may not be a good measure of retail intensity, but we still look at this measure as this is what determines the heft of passive funds.

Passive Mutual Fund Schemes	AUM Feb-24 (₹ Crore)	AUM Apr-23 (₹ Crore)	Growth (%)
Silver ETF	4,143.77	1,785.73	132.05%
Equity oriented Index Funds (Domestic Index Funds)	93,923.45	54,355.39	72.80%
Fund of funds investing overseas in Passive Funds	7,832.47	5,427.23	44.32%
Equity oriented ETFs (International ETFs)	10,866.69	7,975.68	36.25%
Equity oriented ETFs (Domestic ETFs)	5,34,289.39	4,08,915.17	30.66%
Equity oriented Index Funds (International Index Funds)	4,286.32	3,396.94	26.18%
Gold ETF	28,529.88	22,949.98	24.31%
Income/Debt Oriented ETFs	95,535.41	83,483.85	14.44%
Income/Debt Oriented Index Funds (Other than TMIF)	14,675.84	14,385.82	2.02%
Fund of funds investing overseas in Active Funds	17,099.84	17,211.62	-0.65%
Income/Debt Oriented Index Funds (TMIF)	93,629.32	95,319.83	-1.77%
Other Index Funds	3,271.63	3,635.52	-10.01%
Total of Passive Schemes	9,08,084.00	7,18,842.76	26.33%

Data Source: AMFI (TMIF is target maturity index funds)

We have compared AUM of various passive fund categories for February 2024 over April 2023. The share of passive funds in AUM is 16.65% as of February 2024 (lower than 16.76% as of the close of January 2024) and growing. Here is what we read.

• AUM of passive funds grew 26.33% in February 2024 over April 2023. Much of the accretion in the AUM has obviously come from Nifty and Sensex and Sensex touching all-time highs, although the flows are tepid, which is evident from lower market share.
• Index ETF AUM has touched ₹6.30 Trillion and it has emerged as the single largest contributor to the overall mutual fund AUM. In fact, the equity index ETF AUM alone is more than the AUM of liquid funds. The second best category of liquid funds only has AUM of ₹5.17 Trillion. Low cost structures have driven flows into passive funds & ETFs.
• The leader of the pack in terms of AUM growth was, once again, silver ETFs, a recent addition, which saw AUMs growing by 132.05% over April 2023. That is stupendous growth in just 10 months, albeit on a low base. The other categories of passive funds that saw good traction in the last 10 months were domestic equity index funds at 72.80%, FOFs investing in overseas passive funds at 44.32%, international equity ETFs at 36.25%, and domestic equity ETFs at 30.66%.
• On the downside, miscellaneous index funds saw AUM contraction of -10.01% while Target Maturity Index Funds (TMIF) saw AUM contract by -1.77%. Out of the 12 categories of passive funds with existing folios, 9 categories of passive funds saw AUM accretion while 3 categories saw AUM contraction.

The growth in passive AUM has come on the back of index accretion, although flows have been tepid in the last few months. That is more because the bias in the current market is more towards alpha hunting and not so much about settling for just Beta risk. However, in a volatile market, this is at best likely to be a temporary phenomenon.

Passive funds – the story of the last 7 years

Mutual fund growth post-pandemic has seen surge of interest in passive investments like index funds, index ETFs etc. We will now look at the story of the last 7 years on passive funds from four perspectives. The AUM of ETFs, AUM of Index Funds, Flows of ETFs and the flows of index funds. Here are four key takeaways from what we gathered from the passive fund data of the last 7 years.

• Firstly, what have we read from the index ETF AUM data of the last 7 years. All data is as of December 2023, when the last quarterly data was comprehensively reported. Total AUM of ETFs stood at Rs6.50 trillion as of December 2023. Out of this, equity ETFs accounted for 81.47% of the index ETF AUM, debt ETFs accounted for 13.86%, gold ETFs accounted for 4.20%, and silver ETFs accounted for the balance 0.47%. Between March 2020 and December 2023, the total AUM of index ETFs has grown nearly 4-fold.
• Secondly, what did we read from the index Fund AUM of the last 7 years. Here again, latest data pertains to December 2023 only. Total AUM of index funds stood at Rs2.00 trillion as of December 2023. Out of this, equity index accounted for 44.82% of the index fund AUM, while debt index funds accounted for the balance 55.18%. Between March 2020 and December 2023, the total AUM of index funds has grown nearly 24-fold.
• A clearer picture of the slowdown is evident when we look at the flows into ETFs. The net flows into ETFs fell from Rs80,850 crore in FY22 to Rs59,526 crore in FY23 and further to just Rs25,301 crore of net flows in 9 months of FY24. Gross flows have still been robust, which indicate that there has been sustained redemption at higher levels.
• Finally, what about the flows into index funds? The inflows were substantial in FY23 but has come down sharply in FY24, largely due to the absence of NFOs or the government initiative to boost sale of public sector shares through the index fund and index ETF route. Of course, the flows (in this case) would be largely a function of the NFOs.

Crystal gazing passive funds; for now, and beyond

Passive funds may be down, but they are far from out. In India, the share of passive funds at under 20% of the AUM is still too low by the standards of other developed countries. As markets get more competitive for mutual funds, there is likely to be a bigger shift. Now, there are names like Zerodha and Jio-Blackrock; that are likely to purely focus on passive funds. As Jack Bogle of Vanguard remarked wryly, “The grim irony of investing is that investors not only don’t get what they pay for; but they earn what they don’t pay for.” That is convincing enough that indexing is here to stay.