Pays to be passive

ETFs are finding favour among both fund houses and investors

By OLM Desk

Tell us why you need an index and where do passive ETFs fit in?
The need for index is based on rules that define them. So, factors like liquidity, type of constituents of the index and any other such factor go into building one. Once the index is created, it becomes easy for investment portfolios to be benchmarked to peg the performance of a fund. We provide indices recognising the need for choices and are creating innovative and varied options to suit the market. As far as ETFs are concerned, these are funds based on an index composition that we develop and are passive investment options for investors.
I am witnessing a growing trend of passive investing in India. Although the market still offer alpha to active fund managers, some market participants are moving toward index-based investing. ETFs are an innovation that potentially lower costs as a result of fewer intermediaries, reduced administration expenses, lower marketing costs due to the availability of online platforms, and a move toward increased automation. The CPSE ETF has helped in creating a wider investor acceptance to the ETF.

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Is there any role for ETFs in India?
Globally, over $3 billion worth of assets are managed by ETFs and there is growth opportunity for ETFs in India as well. There is a role for active investment and one for passive investing as well. Advocates of active management argue the ability of active funds to outperform benchmarks and hence they being superior. However, investor needs vary between active and passive management. Moreover, many a times, the investment objective of an actively managed fund is such that there is no right-fitting benchmark that its performance can be pegged to. In such cases, the fund may choose a less relevant benchmark index, which it may be able to outperform purely because it is not the right yardstick for comparison.
For instance, take a dividend fund, which should ideally be compared to a dividend index rather than a generic market benchmark like the S&P BSE Sensex or the S&P BSE 200. As the comparison is not apples-to-apples, the results will always vary and sometimes skewed towards active fund manager. Definitely, there is a need for passive fund management in India, and once it picks steam, there will be a lot many takers for passive investing.

What are the ETF trends you are seeing in India?
The trend of passive investing is growing. Although market conditions are still offering active fund managers ample room to beat the benchmark, some market participants are moving toward index-based investing. The growing scope of passive investing could increase this segment of the market place significantly.

But, isn’t passive investing limited to the possible index benchmark?
You will be amazed to know of the many index possibilities and the many that currently exist in India. Index classification is not only restricted to market capitalisation—there are a number of other categories to choose from as well. There are regional indices to cover specific geographies, there are sector indices offering other splits, like information technology, auto, banking, and financial and manufacturing. There is also the asset class-based index, which means there is either equity or fixed income or commodities in the index universe. There is also the Shariah index series, which uses screening techniques to provide a variety of indices that are Shariah compliant. Then there are custom indices which can be created from standard classifications, offering another wide range of choices.

Can you give an example of how passive can be better than active?
There is room for both to grow and earn returns. As I told you earlier, the success of active management is directly related to its outperformance of the benchmark it is pegged to. In order to ensure consistency, active managers are reluctant to deviate from standards that include this comparison. This leads them into situations where they may have to hold a position that may not necessarily be attractive to them, or there may be excessive movement of positions in the portfolio, resulting in additional costs and turnover. Hence, a fund manager’s choice and conviction play a part in active strategy. However, this being an individual choice brings in bias, which may work in certain market conditions and may not in others. This is not the case with passive at all, which is all about discipline and focus on the benchmark and rules that are set for investments to mirror them. I would say, for first time investors into equities, ETFs would be a good start.


Koel Ghosh, Head of Business Development, South Asia, S&P Dow Jones Indices