The S&P Dow Jones Indices (a division of S&P Global) releases the S&P Indices Versus Active Funds (SPIVA) Scorecard every year. The report compares the performance of actively managed funds with their respective benchmark indices over 1, 3, 5, and 10-year investment horizons. The 2022 report showed that 96.7% of the Indian large-cap active funds underperformed the benchmark index (S&P BSE 100) over the 3-year period. Over the 1-year period, 87.5% of large-cap active funds underperformed, and over the 5-year period, 93.8% of funds underperformed the S&P BSE 100 index.
With such high underperformance by active funds, should you switch to index funds?
Let us check the SPIVA India Scorecard (2022) to compare the performance of active funds in various categories with their respective benchmark indices over various investment horizons.
SPIVA India Scorecard – 2022
The above table shows:
Large-cap active funds: The underperformance compared to the S&P BSE 100 index over 1-year (87.50%), 3-year (96.67%), and 5-year (93.75%) periods is high. Over the 10-year period, the underperformance reduced to 67.91%.
ELSS active funds: The underperformance compared to the S&P BSE 200 index over a 5-year (95.35%) period is high. Over the 1, 3, and 5-year periods, the underperformance reduces. But the overall underperformance still remains high.
Mid and small-cap funds: The underperformance compared to the S&P BSE 400 MidSmallCap index is lower compared to large-cap and ELSS categories versus their respective comparison index. However, the overall underperformance remains high, around 50% or higher over 1, 3, and 10-year investment periods.
Benefits of investing in passive funds
The cost (expense ratio) of investing in active funds is higher than passive funds. So, with such high underperformance of active schemes, specifically in the large-cap category, should you shift to passive funds? Let us look at some of the benefits of passive schemes.
Lower costs
The expense ratio of passive funds is lower than that of active funds. Most passive funds have an expense ratio lower than 1%. It is usually in the 0.1 to 0.5% range. The expense ratio impacts the net returns that you will earn. Hence, the lower the expense ratio, the better.
Diversification
Passive funds invest in all the benchmark index constituents as per their weightage. Most market capitalisation-based broader indices have companies representing most of the sectors of the economy. So, passive funds offer you diversification, which spreads your risk.
Index returns
Passive funds mirror the performance of the benchmark index as closely as possible. Hence, the returns from these funds mirror the benchmark index's returns. However, note that there will be some difference between your net returns and benchmark returns due to factors such as tracking error, expense ratio, etc.
No human bias
In an active fund, the fund manager decides which stock to buy and sell, when, how much and at what price. However, in a passive fund, the fund manager has no role in buying and selling decisions. Hence, passive funds are free from any human bias.
Investment opportunities in passive funds
Over the last few years, as the investor interest in passive funds has grown, AMCs have launched several passive schemes. These include Exchange Trade Funds (ETFs) and index funds based on indices such as:
1) Nifty 50
2) Nifty Next 50
3) Nifty 100
4) Nifty Midcap 150
5) Nifty Smallcap 250
6) Nifty 500
7) Nifty Microcap 250
You can invest in index funds through a systematic investment plan (SIP). It allows you to invest a fixed amount at a specified frequency (weekly, monthly, etc.) for a specified period. You can invest in a disciplined manner towards your financial goals.
The growth of passive funds in India
Many investors have started investing in passive funds in the last few years. In the last five years, the asset under management (AUM) of passive funds has grown 8.5 times from Rs. 83,000 crores to Rs. 7,00,000 crores. The growth rate has been a staggering 54% CAGR.
With the rapid growth in the AUM, passive funds constitute a 17% market share of the total mutual funds industry AUM compared to just 1.4% in 2015.
Should you shift to passive funds?
In the large-cap category, due to the underperformance of most active mutual funds compared to the S&P BSE 100 index, a case can be made for investing in index funds. The passive funds in the large-cap category include those that have the Nifty 50, Nifty Next 50, or the Nifty 100 index as the benchmark.
However, the performance of active mid and small-cap funds (compared to their respective benchmarks) is better than that of large-cap funds. Regarding mid and small-cap funds, consider the following two scenarios: you can go for active funds if you have a higher risk appetite than the overall market risk, and are looking for alpha over the index returns or go for passive funds if you are content with index returns.
Disclaimer: We advise investors to check with certified experts before taking any investment decisions.
Gopal Gidwani is a freelance personal finance content writer with 15+ years of experience. He can be reached at LinkedIn.
