Time to go passive?

Until a couple of years ago, Indian investors buying equity mutual funds looked upon actively managed funds as their default choice without giving index funds a second thought. That was because trailing returns on actively managed funds across equity categories showed these funds convincingly beating their benchmarks. But as active funds have struggled against their benchmarks lately, many Indian investors have begun to question if they should make the switch from active funds to passive funds and pocket some neat savings on costs. The unmistakable wave towards passive funds in the global context and the burgeoning variety of index products in India are adding to this interest. Therefore, before jumping the gun to make a wholesale switch to passive investing, it is important to understand what's driving the recent underperformance. Three factors seem to be at play in active funds struggling against their benchmarks recently. 1. The total return effect How an equity fund performs depends on what it is measured against. Until 2017, the majority of AMCs in India (except for a few like Quantum, Edelweiss and DSP Mutual Fund) used to benchmark their equity schemes against plain price indices instead of the total return indices. But cottoning on to this shortcut, from February 1, 2018, SEBI decreed that all equity funds must benchmark themselves against total return indices rather than plain price indices. Given that dividends add about 1.2-1.3 per cent to the annual returns from indices such as the Sensex and Nifty on a yearly basis, this has whittled down one of the sources of spurious alpha for active funds. 2. Tighter mandates A second regulatory tweak by SEBI which has made life more challenging for active managers is its recategorisation exercise in October 2017. Before