Passive investing is about simplicity; dont give into active fund management lurking in the garb of thematic passive funds The proliferation of quasipassive funds adds to the overwhelming array of investment options. It places the burden of sectoral and thematic allocation on their shoulders, a task that requires expertise, time, and a deep understanding of the markets. Moreover, these narrowly focused index funds often carry higher expense ratios
Dhirendra Kumar
CEO, Value Research
There’s a curious charade playing out in the Indian mutual fund industry, one that turns the very concept of passive investing on its head. Fund houses have discovered a convenient loophole in Sebi’s regulatory framework and are enthusiastically exploiting it.
#sr_widget.onDemand p, #stock_pro.onDemand p{font-size: 14px;line-height: 1.28;} .onDemand .live_stock{left:17px;padding:1px 3px 1px 5px;font-size:12px;font-weight:600;line-height:18px;top:9px} #sr_widget.onDemand .sr_desc{margin:0 auto 0;} #sr_widget.onDemand .sr_desc{color: #024d99;margin-top:10px;} #sr_widget.onDemand .crypto .live_stock .lb-icon{8px 6px 5px 3px !important} #sr_widget.crypto.onDemand a.text{border-bottom:1px solid #ccc;padding-bottom:5px;display:block;width:100%} #sr_widget.onDemand .sr_desc .text p, #stock_pro.onDemand .sr_desc .text p{font-size:12px;font-weight:400;} Sebi sensibly limits AMCs to launching just one actively managed fund in each plain category. This prevents the proliferation of near-identical products and reduces investor confusion. One large-cap fund, one mid-cap fund, and so on. It’s a straightforward approach that benefits everyone. Except that there’s a catch. This limitation doesn’t apply to passive funds. If there’s an index, a fund based on it can be launched. Therein lies the opportunity that fund houses have pounced upon—commission custom indices and launch ‘passive’ funds tracking them.
The result? An absurd multiplication of indices. The National Stock Exchange now offers at least 120 equity indices, while the Bombay Stock Exchange has at least 64. While not all are created specifically for fund houses, they are readily available for AMCs. We now have indices with names like ‘Alpha Quality Value Low Volatility 30’, ‘EV & New Age Automotive’, ‘ESG’, ‘Enhanced ESG’, and my personal favourite, ‘ESG Sector Leaders’. This isn’t innovation; it’s simply clutter masquerading as choice.
Let’s be clear about what’s happening. These aren’t genuine passive funds in the spirit of the concept. True passive investing is about simplicity, capturing the overall market return without attempting to outperform it. When you invest in a Nifty index fund or a Sensex fund, you buy the market, and are not making a specific bet on which segment will outperform. However, these ‘passive’ funds require very active decisions from investors. Should you invest in a banking index fund or a healthcare one? An ESG index or a momentum index? Suddenly, you are making precisely the kind of allocation decisions you were trying to avoid by choosing mutual funds in the first place.
The entire point of investing in a mutual fund is to outsource these decisions to professionals. You pay a fund manager to determine which sectors are attractive, which themes have potential, and which stocks represent good value. When you select a thematic ‘passive’ fund, you are effectively taking back that responsibility while still paying for professional management. It’s worth remembering why passive investing gained popularity in the first place. Research shows that most active managers failed to beat broad market indices over the long term. However, the solution wasn’t to create hundreds of narrow indices, but simply to track the broad market cheaply.
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We are witnessing active management in disguise: fund houses creating bespoke indices that reflect particular investment viewpoints, then labelling the resulting products as ‘passive’. This gives them two advantages: they can launch multiple funds in the otherwise restricted categories and promote new funds, which are always easier to sell than the existing ones.
However, the consequences for investors are less beneficial. The proliferation of these quasi-passive funds adds to the overwhelming array of investment options. It places the burden of sectoral and thematic allocation squarely on their shoulders, a task that requires expertise, time, and a deep understanding of the markets. Moreover, these narrowly focused index funds often carry higher expense ratios than the true, broad market index funds, eroding one of the key benefits of passive investing—low costs.
The solution? Return to first principles. If you choose passive investing, embrace its genuine philosophy: broad market exposure, minimal costs and simplicity. Combining one or two broad market index funds will serve most investors better than a collection of narrow thematic funds. If you want exposure to specific sectors or themes, consider whether a well-managed, diversified active fund serves that purpose. At least you are explicitly paying for the manager’s expertise to shift allocations as market conditions change.
In investing, as in many areas of life, simplicity often trumps complexity. When ‘passive’ becomes this active, it’s time to step back and question what we are really paying for.
The Author is CEO, VALUE RESEARCH
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This story originally appeared on: India Times - Author:Faqs of Insurances
