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What is the future of passive funds in India?

While active large-cap funds are giving way to passive funds, actively managed multi-cap funds still have their golden days ahead, says Dhirendra Kumar

What are your thoughts on investing active funds as against investing in index funds? What is the future of passive funds in India?
- Rajeev Dhandhurti

I believe that unlike index funds in the US and Europe, index funds in India are different because of several factors, including the Indian market, the behaviours of Indian investors and the kind of institutional money that finds its way into these funds. In countries like the US, the entire economy is publicly listed which is not the case with India.

A good part of our economy is not publicly listed and hence, one cannot buy the shares of these companies. Besides, the US has long-term pension plans like 401K that makes a sizable investment in index funds. So, it becomes a self-fulfilling prophecy in the sense that people put more money in index funds and the index stocks go up. Even though we have NPS which is somewhat equivalent to 401K and now EPF also invests a part in index funds, the size or the scale is very less.

Indexing is definitely making inroads, especially into the large-cap category. Active large-cap funds have lost their plot in terms of the cost advantage to index funds. These funds have to return about 2 per cent more than the index to be at par with index funds, owing to the higher management fee.

However, I still believe that given the breadth of under-researched market that India has, our multi-cap funds had a compelling performance over the past 5-10 years. Thus, this segment of actively managed funds still has its golden days ahead and has a strong case in its favour at least for the next four-five years till passive funds make inroads in this category as well. However, the large-cap funds have lost their case to the index fund.

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