How passive investing can help your portfolio get international exposure?

The Indian markets have been witnessing steady inroads in the realm of passive investing. The passive investing segment has been abuzz with activity with new and old fund houses joining the bandwagon. While the last couple of years have witnessed a steady spurt in passive funds with more and more retail investors flocking to them, India still has a long way to go in the arena of passive investing considering how popular they have been in some countries, especially developed economies.

According to a report by S&P Global, as of March 2020, global assets in passive products passed USD 5 trillion, with over 7,000 passive products. The U.S., with a market share of 68%, USD 3.6 trillion in assets, and over 2,000 products, is followed by Europe and Japan with 16% and 6.5% of market share, respectively. “For India, though the numbers are far more modest, the growth has been encouraging, with the total assets under management in passive products at USD 24 billion and 86 passive products. Five years ago, the scenario in India included a mere USD 2 billion in assets and 57 products. A decade back had far less, with USD 1 billion and 26 products in the market,” the report said.

More than just a fad

Passive investing is a long-term investment strategy for wealth creation that entails buying securities by replicating stock market indices. The objective is to mirror the performance of an index by holding the same securities as the index and in the same proportion in the long-term. Passive investing largely revolves around a buy-and-hold strategy and there is minimal trading involved. As such passive investing incurs lower costs due to reduced trading volumes and passive funds are transparent and easy to understand making them a good investment choice for novice investors.

Deepak Chhabria, CEO of Axiom Financial Services says, “Passive investing has gained acceptance and traction in recent years. Earlier, it was more or less certain that open ended mutual fund schemes will outperform the index and generate alpha, but, as the markets mature, and information flow becomes linear, outperforming the benchmark especially in large cap funds is difficult. This has prompted many investors to look at passive investing through the ETF route and index funds.”

Preeti Zende of Apna Dhan Financial Services explains what makes passive investing stand out, “Mutual fund investing offers two types of investment options. One is active investment style where you invest in active mutual funds where fund managers use their skills, experience and research for trying to generate the alpha for you by taking the bets accordingly. Whereas in passive investing, no active role of a fund manager is there. The fund will simply invest in the indices which it made up off. So, the alpha will be in accordance with the performance of that index. Passive investing is a good strategy for long term wealth creation and there is no need for frequent monitoring of the portfolio.”

Exposure to the international markets

Another reason why passive investing has started to find favour among Indian investors is because it can be a hassle-free way to get international exposure to your portfolio. Chhabria explains, “The average Indian consumer is exposed to many foreign brands on a daily basis, if we analyse our consumption basket, surprisingly a large number of products that we consume are made by MNCs which are not listed in India. The best way to participate in the growth of these companies is by investing in their stocks. Thus, global Investing is not a fad, but a necessity. Investing directly overseas may not be possible for all investors, as this involves opening trading accounts with brokers, foreign currency fund transfer under LRS (Liberalized Remittance Scheme), and conducting research on listed companies, tracking would be another issue. The best route for average investor is to avail many Index funds and ETFs of foreign indices that are being offered by India AMCs through fund of funds route.”

Chhabria opines that the benefits of passive investing are ample, and investors should make use of the growing popularity of passive investing in India and dabble with passive funds. “Passive funds are low-cost investment options and there is negligible fund manager risk. ETFs capture real time market movement and more importantly overseas exposure gives currency hedge to your portfolio and de-risks it from domestic market volatility. ETF and Index funds can exhibit lower volatility than open ended schemes and one can pick and choose sectors and themes not available in the domestic market.”

The passive investing game is here to become entrenched in India and there is no reason why you should not reap its benefits, especially in terms of spreading your investment across global markets. A report by Finity, a fintech specialising in passive and direct mutual fund schemes, estimates the AUM of passive funds to cross ₹25 lakh crore by March 2025 from ₹3 lakh crore in March 2021. In other words, it estimates that the share of passive AUM in the overall assets of the Indian mutual fund industry will surge from 10 per cent as of March 2021 to 37 per cent in March 2025.

How to subscribe to index funds?

You can invest in index funds either directly or through an agent. There are a plethora of online platforms through which you can invest in these funds without much hassle. You can invest online directly through the websites of fund houses, or you can invest offline by visiting a branch of a fund house.

As with other mutual funds, index funds are available in direct and regular mode. In the case of the former, you can invest directly through an asset management company and in the case of the latter, the investment is made through a distributor, agent or a broker. Also, while demat accounts are required for ETFs, you do not need them for index funds.

The taxation of index funds is similar to that of equity-oriented funds - any short-term capital gains with an investment period of less than a year will attract taxes at the rate of 15%. While long term capital gains (when the holding period is 12 months or more) are taxed at 10%. Since the passive investment strategy does not depend on human intervention and seeks to minimize investment risks arising due to bias, investors do not have to incur fund managers’ charges and as such these funds are low-cost investment products.

Key takeaways

- With more and more fund houses expanding their passive fund offerings, it is advisable to thoroughly research your options before picking a fund.

- Passive funds can get a certain percentage allocation of your portfolio depending on your goals and risk-taking abilities.

- Earlier, it was more or less certain that open ended mutual fund schemes will outperform the index and generate alpha, but, as the markets mature, and information flow becomes linear, outperforming the benchmark especially in large cap funds is difficult. This has prompted many investors to look at passive investing through the ETF route and index funds.

- Passive funds are low-cost investment options and there is negligible fund manager risk.

This article is part of the HT Friday Finance series published in association with Aditya Birla Sun Life Mutual Fund.