Passive Insights: How index funds and index ETFs grew in Q3FY24

31 Jan 2024 , 12:31 PM

Why Q3FY24 was a tepid quarter for passive flows

It is said that when the going gets tough, the tough get going. Incidentally, the last quarter ended December 2023 had easy pickings in direct equities. People invested in direct stocks, equity funds (especially mid-cap funds and small cap funds) were laughing all the way to the bank. That is hardly the time when passive investing looks exciting. However, one must not miss the wood for the trees. The Nifty yielded 20% returns in 2023. That means; a passive investment in an index fund or index ETF, benchmarked to the Nifty, would have made you 20% richer. As much as easy pickings can temporarily shift attention from passive investing, they also underline the core philosophy that staying invested in the stock markets is all that matters. The longer, the better.

We look at two popular quotations of Jack Bogle which put the current quarter in perspective, as far as passive investments are concerned. According to Bogle, “In investing, you get what you don’t pay for.” What this means is that if you reduce your costs in investing, you can magnify your returns over time. Costs matter because even the most optimistic investor knows that it is impossible to consistently beat the market. Another quote by Bogle, “There is no doubt that the first index fund was the most successful innovation for investors.” These two quotes by Jack Bogle underline why passive investing goes beyond one quarter performance. Passive investing is about reducing costs  of investing and it is because nobody consistently beats the market.

How index ETFs have grown in the last 7 years in India

Today, passive investment through index ETFs and index funds has become a significant part of overall mutual fund AUM. The table below captures the gist the growth in index ETF AUM last few years. These are cumulative numbers

Period FY Reference	Equity ETF  (₹ in crore)	Debt ETF (₹ in crore)	Gold ETF (₹ in crore)	Silver ETF (₹ in crore)	Total ETF (₹ in crore)
Upto Mar-17	43,234	1,497	5,480	–	50,211
Upto Mar-18	71,841	2,017	4,806	–	78,664
Upto Mar-19	1,32,687	2,278	4,447	–	1,39,412
Upto Mar-20	1,29,751	16,640	7,949	–	1,54,340
Upto Mar-21	2,37,903	37,672	14,123	–	2,89,698
Upto Mar-22	3,49,330	61,256	19,281	777	4,30,644
Upto Mar-23	3,97,082	85,406	22,737	1,792	5,07,017
Upto Dec-23 #	5,29,859	90,135	27,326	3,033	6,50,353

Data Source: NSE (# refers to 9 months of fiscal year 2023-24)

Here are some key takeaways from the ETF growth story for the latest quarter ended December 2023, with a perspective view of the last few full years.

• The numbers say it all. The AUM of index ETFs has grown from Rs50,211 crore in FY17 to Rs6,50,353 crore as of December 2023. That is a 13-fold growth in a little over 6 years. One can argue that a good chunk of this accretion is from the Nifty and the Sensex nearly doubling in this period. However, a 13-fold increase still implies that fresh flows into these index ETFs have been fairly strong and robust in this period.

   

• While ETF AUMs are largely dominated by the equity ETFs, debt ETFs are also catching up. Gold and silver ETFs are relatively much smaller. However, the bigger story is the frenetic growth post the pandemic . Between March 2020 and December 2023, the overall AUM of ETFs has grown from Rs1.54 trillion to Rs6.50 trillion. The growth has been robust across equity index ETFs, debt index ETFs and gold ETFs.

   

• As of December 2023 close, there were a total of 190 index ETFs in India, which comprised of 141 equity index ETFs, 24 debt index ETFs, 15 gold ETFs and 10 silver ETFs. There are a total of 69 different indices being tracked by index ETFs, which include 55 equity indices and 14 debt indices.

   

• What about the folios? Index ETFs alone have 124.62 lakh folios. Out of these individual retail investors account for 121.88 lakh folios or 98% of the total folios while the HNI investors account for 2.13 lakh folios or nearly 2%. The folios share of FPIs, banks and corporates are quite insignificant.

   

• However, the story entirely changes if one were to look at the AUM share of the various stake holders in index ETFs. Out of the total ETF AUM, corporates account for a whopping 91% of the overall index ETF AUM, HNIs account for 6%, Retail investors account for just 2% of the AUM, while banks and FPIs account for the balance 1% of AUM.

Clearly, the growth of index ETFs over the last 7 years has been robust. Despite the massive rally in the equity indices in the December 2023 to new historic highs, the index ETF flows have continued to be strong, indicating that there is a niche market for such passive products in India.

Let us turn to the growth of index funds in last 7 years

Unlike index ETFs (which are exchanged traded products), index funds are like regular mutual funds that are based on day-end NAVs and where the fund offers repurchase and sale on a continuous basis based on NAV linked prices. Another difference is that the index ETFs were based on real time prices during market hours linked to NAV values. On the other hand, the index funds are like regular mutual funds, in that they rely on day-end NAVs announced by the AMC. In terms of size, the index funds are relatively smaller than index ETFs in terms of AUM. Also, the costs of index funds are relatively higher than index ETFs, although one can argue that the difference may not be much if the market costs of ETFs like broking costs, statutory charges, demat expenses, and liquidity related basis risks are also accounted for. Here is the index fund story over the years.

Period FY Reference	Equity Funds (₹ in crore)	Debt Funds (₹ in crore)	Gold Funds (₹ in crore)	Total Funds (₹ in crore)
Upto Mar-17	2,452	–	–	2,452
Upto Mar-18	3,061	–	–	3,061
Upto Mar-19	5,237	–	–	5,237
Upto Mar-20	8,056	–	–	8,056
Upto Mar-21	18,107	883	–	18,990
Upto Mar-22	39,638	27,609	–	67,247
Upto Mar-23	55,557	1,05,219	–	1,60,776
Upto Dec-23 #	89,480	1,10,143	–	1,99,623

Data Source: NSE (# refers to 9 months of fiscal year 2023-24)

Here are some key takeaways from the index fund growth story for the latest quarter ended December 2023, with a perspective view of last few full financial years.

• The AUM of index funds has grown from Rs2,452 crore in FY17 to Rs1,99,623 crore as of December 2023. That is an 81-fold increase over 6 years, but it is on an extremely small base, so numerical comparisons can be generally misleading. While some part of this accretion is from index appreciation, a good chunk does come from fresh flows. As we shall see later, the flows into index funds are not of the same order and magnitude as the flows into index ETFs. Clearly, the listing aspects appears to work in favour of index ETFs, especially for the traders who are already exposed to equities, through their trading and demat accounts.

   

• In contrast to the ETF story, debt index funds have dominated the market share but equity index funds are also fast catching on. In fact, the growth in Aum of equity index funds and debt index funds has been fairly rapid post the pandemic crisis of March 2020. In fact, the debt index fund growth was entirely a post-pandemic phenomenon. One of the things that should work inf favour of index funds is that there is no SEBI restriction on the number of index funds that a particular AMC can have.

   

• As of December 2023 close, there were a total of 195 index funds in India, which comprised of 110 equity index funds, 85 debt index funds. There are a total of 111 different indices being tracked by index funds, which include 40 equity indices and 71 debt indices.

   

• What about the folios? Index funds alone have 53.88 lakh folios as of December 2023; an accretion of over 20% over the number of folios as of the end of September 2023. Out of these folios, individual retail investors account for 50.61 lakh folios or 94% of the total folios while the HNI investors account for 3.01 lakh folios or nearly 6%. The folios share of FPIs, banks and corporates together are quite negligible.

   

• However, the story entirely changes if one were to look at the AUM share of the various stake holders in index funds. Out of the total index funds AUM, corporates account for a whopping 49% of the overall index fund AUM, HNIs account for 38%, and retail investors account for just 13% of the AUM. The AUM share of banks and FPIs in the total index fund AUM was quite insignificant.

Index funds have not shown the same enthusiasm as they started off with as many investors appear to have gravitated towards index ETFs due to their inherently lower costs and real time price availability. Index funds were limited to investors not active in direct equities.

Story of passive flows over the last 7 years

We will now take a quick look at how the flows into index funds and index ETFs panned out over the years in terms of gross flows and net flows. Gross flows reflect the interest levels and net flows show the direction of flows. Let us look at the index ETFs first.

Period FY Reference	Mobilizations (₹ in crore)	Redemptions (₹ in crore)	Gross Flows (₹ in crore)	Net Flows (₹ in crore)
FY 2016-17	41,335	17,281	58,616	24,054
FY 2017-18	58,341	34,383	92,724	23,958
FY 2018-19	1,00,158	56,807	1,56,965	43,351
FY 2019-20	1,23,008	63,198	1,86,206	59,809
FY 2020-21	1,06,512	66,692	1,73,204	39,820
FY 2021-22	1,39,616	58,766	1,98,382	80,850
FY 2022-23	1,56,162	96,635	2,52,797	59,526
FY-2023-24 #	98,022	72,721	1,70,743	25,301

Data Source: NSE (# refers to 9 months data)

What would strike you is not the rather steady net flows, but the rapid spike in the gross flows. The gross flows are the aggregate of inflows and redemptions and that has gone up between FY17 and FY23 by nearly 4.5 times. That shows the rising volumes of trading that is happening in these index ETFs, hinting at a surge in investor interest. At the current run rate, it looks like FY24 can beat FY23 in terms of gross flows into index ETFs.

Let us now turn to how the flows story look like for the index funds. The data available is for last 4 years prior to the first 9 months of FY24. But that should still offer the broad trends.

Period FY Reference	Mobilizations (₹ in crore)	Redemptions (₹ in crore)	Gross Flows (₹ in crore)	Net Flows (₹ in crore)
FY 2019-20	8,222	3,205	11,427	5,017
FY 2020-21	12,880	8,301	21,181	4,579
FY 2021-22	55,920	11,161	67,081	44,759
FY 2022-23	1,26,511	30,840	1,57,351	95,671
FY-2023-24 #	34,872	26,530	61,402	8,342

Data Source: NSE (# refers to 9 months data)

Like in the case of index ETFs, even in the case of index funds, the growth has been very frenetic post the pandemic. If you ignore the latest half year, the one trend is the much better net flows in the case of index funds, as compared to index ETFs. However, that can be attributed to the higher share of debt index funds in the mix, where the stickiness tends to be higher by default. However, the moral of the story is that; passive funds are a narrative which have well and truly arrived in India!

Why did  pandemic make a difference to passive flows?

People often wonder why the pandemic made a difference to the interest in passive investing. There were 3 broad reasons. Firstly, the pandemic underscored the value of equity as an asset class and the power of allocation. The investors who used even passive strategies to allocate more to equities in the pandemic, ended up a lot richer. Secondly, the pandemic was like a mirror that separated the resilient business models from the not-so resilient ones. This led to the kurtosis effect. Lastly, the pandemic underlined that it is more important to prepare for uncertainty, rather than try to predict it!