Passive funds dominate NFO line up as most active fund lag benchmarks

Fund houses have launched ETFs in both equity and debt segments

Every other new fund offer (NFO) launched by mutual fund (MF) houses in recent times has been in the exchange-traded fund (ETF) or index fund space. Experts say this trend is an acknowledgement of the growing popularity of passives as investment vehicles.

Fund houses have lined up passive funds both on the equities as well as on the debt side. Examples of such funds are UTI Momentum Index Fund, Edelweiss MSCI India Financials Index Fund, and two fund-of-funds by Motilal Oswal that invest in passive funds. On the debt side, the fund house has also launched the Motilal Oswal 5 Year G-Sec ETF.

The low cost of investing, coupled with recent outperformance, has given an impetus to ETFs, say experts. “If you look at the trend worldwide people are moving towards passive funds because costs are rising, revenues are shrinking, and it is becoming increasingly difficult to beat the benchmark,” said Jimmy Patel, managing director and chief executive officer of Quantum Asset Management Company.

Only last month, the assets under management (AUM) of domestic ETFs topped the Rs 2-trillion mark. ETFs based on the Nifty 50 index alone have cumulative AUM of Rs 1 trillion.

In the past few years, many actively-managed funds have failed to beat their benchmark returns, prompting investors to shun these funds in favour of passive investing.

A passive fund tracks a market index. The fund manager does not actively choose what stocks the fund will be comprised of, unlike in an active fund. An NFO is the first-time subscription offer for a new scheme launched by a fund house. Fund managers said the polarisation of the market in recent times has made it challenging for active funds to generate the outsized returns over their benchmark.

To illustrate, an actively managed fund can’t invest more than 10 per cent of the scheme’s corpus in a single stock. Meanwhile, Reliance Industries, which has been a big outperformer this year has nearly 15 per cent weighting in the benchmark Sensex. As a result, most active funds have been underweight on the stock.

Sunil Subramaniam, MD, Sundaram Mutual, said being diversification vehicles MFs cannot benefit when there is a high polarisation in the market. The low-cost structure of passive funds also makes it attractive for fund houses who want to give their customers a wide basket of choices. Further, market participants said passive funds are helpful if the asset management companies (AMCs) want to launch a MF wrap under a fund of funds. The changes in the MF distribution system with the advent of registered investment advisors (RIA) have also tilted the balance in favour of passive funds. Experts said active funds limit the earnings for an RIA because part of the fee is taken away by the asset manager. “RIA gets his compensation for his advice on asset allocation. Naturally, they will prefer low-cost products to deploy money. Otherwise, there will be double cost as the customer has to pay the fund manager and the RIA fees,” said Subramaniam.

Experts said MFs would move towards passive funds to control costs. However, the shortage of well-developed indices in India will be a challenge. “There is not much liquidity if you launch an index fund on a small or mid-cap index. But if there is supply, there will be demand, and liquidity issues will get resolved,” said Patel. If an investor needs exposure to small- or mid-caps, there are barely any ETFs in the domestic market. The performance of most actively managed funds operating in this universe has been better than benchmarks. 

Since the beginning of 2020, 51 open-ended NFOs have been launched, and they have collected Rs 20,664 crore. In the closed-ended category, 30 NFOs have been launched, and they have collected Rs 1,107 crore. However, the number of closed-ended NFOs has declined drastically after the Covid-19 outbreak. Only one close-ended NFO has been launched since May.

NFOs in the passive space

• UTI Momentum Index Fund
• Motilal Oswal Asset Allocation Index Fund of Fund 
• Edelweiss MSCI India Financials Index Fund
• Motilal Oswal 5 Year G-Sec ETF
• Axis Banking ETF
• ICICI Prudential Alpha Low Vol 30 ETF