In the past few months, index mutual funds have caught the fancy of investors. Several asset management companies have launched passive mutual fund schemes recently.
There is nothing unusual about this, but it certainly points at a surge in interest in index mutual funds.
In July, there was only one new index scheme that mobilised funds to the tune of ₹5 crore. It rose to ₹203 crore the next month and ₹1,750 crore via 21 mutual fund schemes in October, according to the monthly data reports released by the Association of Mutual Funds in India.
Poor performance of active funds
Experts say this phenomenon is not as black and white as it seems. Some even rue the overemphasis on index funds for the limited investment universe it envisages, and perceive this as a result of underperformance by active fund managers.
In 2021, for instance, most active funds managers failed to beat the indices, a Reuters report noted. During the pandemic period (Mar 2020 - Mar 21), only 3.45 percent large cap funds managed to beat the benchmark index whereas 24 percent mid cap funds and 8.70 percent small cap funds could beat the respective benchmark indices, according to a report by Morning Star India.
“There are many ways to look at the popularity of index funds. First is the underperformance by active fund managers. But when you dig deeper, you will find that largely it is large-cap funds which either underperform or are at par. This is, again, because both the stocks in the Nifty index as well as the stocks which are selected for large-cap funds are generally the same. So, there is not much scope of outperformance,” said Abhishek Dev, Co-Founder and CEO of Epsilon Money Mart.
Vivek Iyer, Partner and leader, Financial Services Risk, Grant Thornton Bharat, also attributes the popularity of passive funds to the difficulty in beating the market index by active fund managers.
“During times of economic uncertainty, there are too many variables at play that make it difficult for an active fund manager to beat the market index and the bigger risk is of negative returns in a search for higher returns. Hence passive funds such as the index funds are a better bet during times of economic uncertainty, which is what we are seeing in the market today,” said Iyer.
Reversion to the mean
Another reason for the popularity of index funds is the inherent belief in the “reversion to the mean” and to stay away from the problem in keeping track of day-to-day upheaval in the market.
For the unversed, reversion to the mean, or mean reversion, is a theory used in personal finance that implies historical returns eventually will move back to the average returns in the long run.
“Investors who do not have the bandwidth to actively invest, can invest in passive funds and yet take part in the overall growth story of the market. This is what has and still makes the index funds very popular,” Iyer added.
Dev, on the other hand, points out that India is a new market when compared to the developed markets like that of US, where index funds are a norm.
“We, in the street, normally believe that everything returns to the balance or mean reversion. So more of the less, active management won't be able to create a lot of value, but when you are a developing economy, a lot of new companies, new moats; new industries get created making active management important. While index funds are low cost, you get the assurance that you won’t underperform. But what about outperformance or creation of alpha? You need active funds for that,” he added.