India’s Potential in Passive Investing

The year 2020 with the COVID-19 pandemic will be marked in history as one of the most-acute pandemics that the world has had to experience.

The passive growth story

The growth trends of passive investing in global and Indian markets are marking new trajectories. The rise of passive investing is the consequence of shortfalls in active performance, as shared in SPIVA (S&P Indices Versus Active funds) Scorecard. It is becoming apparent that there is increased difficulty in outperforming the market on a consistent basis both globally and in India. One category that stands out in its potential for passive allocation is the large-cap space, wherein the benchmark S&P BSE 100 has witnessed outperformance in most periods.

As of June 2020, global assets in passive products passed USD 6 trillion, with over 7,000 passive products. The U.S., with a market share of 69%, USD 4.3 trillion in assets, and over 2,000 products, is followed by Europe and Japan with 16% and 6.7% of market share, respectively. The global asset mix is skewed toward equities, leading with a 71% share in assets at USD 4.4 trillion, followed by fixed income with a 20% share at USD 1.2 trillion. The S&P Dow Jones Indices annual Survey of Indexed Assets shows a surge in S&P 500 indexed assets to $4.6 trillion as of December 2019. The growth in assets tracking the S&P 500 dwarfed the growth due to market gains, indicating a substantial increase in flows.

For India, the growth has been encouraging with the total assets under management in passive products at USD 25 billion and 86 passive products. Five years ago, the scenario in India included a mere USD 2 billion in assets and 57 products. A decade back had far less, with USD 1 billion and 26 products in the market. Hence, the progress made by the country has been remarkable, especially in the backdrop of a faster-paced active investing market. Two years ago, the exchange-traded fund market constituted 2.2% of the mutual fund industry, while in the first quarter of the year it is at 9.1%.

Diversification and Asset Allocation

Asset allocation models are critical to achieving a portfolio’s investment objective. The core and satellite strategy can be used for a diverse selection of indices as the core that provides the benefits of indexing, complemented by an active strategy as the satellite, thereby using a combination of a strategic and tactical allocation approaches to portfolio construction. A strong core provides stability and can contribute to risk mitigation and, ultimately, reaching the financial objective of the portfolio. Indexing offers the benefits of diversification, lower costs, transparency, lack of fund manager bias, flexibility, and a variety of investment categories from which to choose. These options vary from standard market beta to factor-, theme-, or strategy-based indices. Region and asset class can further widen the gamut of options. Given the current uncertainties, diversification is a key risk management tool that ensures risk mitigation. Hence diversifying to international markets, different strategies, themes, sectors, etc. helps in ensuring the portfolio had lesser concentration risk. Further using indexing adds another layer of diversification.