Having passive large-cap index funds is a great idea for the core of the portfolio
Many AMCs (asset management companies) are on overdrive in their zeal for rolling out passive index funds, ETFs and FoFs (fund of funds). And while till just a year or two back, AMCs weren’t so enthusiastic about passive instruments, things have changed a lot now.
They have suddenly accepted these long-ignored siblings of active funds with new enthusiasm.
Passive investors in India have never had it this good. For a lack of a better phrase, there is extreme activity in the passive space!
The result is that investors are spoilt for choice. And with so many new passive funds, many are confused as to which schemes to pick now.
Let’s discuss this based on the market-cap segments.
Large Cap Index Funds: Most investors should stick to Nifty 50 or Sensex-based index funds. For more aggressive investors, adding the Nifty Next 50 index fund makes sense. One of the major reasons for the popularity of index funds was the inability of active large-cap funds to outperform the index.
Mid-Cap Index Funds: In my view, passive investing in the mid and small-cap space is still evolving. Active funds are still doing very well compared to indexes in this market segment. Over time, it’s possible that increasing price discovery will reduce the outperformance of active funds. But still, there are no established track records for passive funds in the space. So, till then, most investors are better off picking well-managed, proven active mid-cap funds. That doesn’t mean that passive options in mid-cap space are without merit. They would suit you if you are satisfied with the index returns, which quite often will be below a few good active funds in the mid-cap space.
Small Cap Passive Funds: As I wrote here in products to avoid (and it may not be a common view), small-cap funds are not needed for most investors. My view hence stands for both active and passive (if any) options in this space.
You may now ask as to what about broader index funds that are being launched now?
As explained in this article on Total Market Index funds, these can be safely ignored, as the expected returns of broader Nifty 750 and that of Nifty 50 are quite similar, most of the time.
Which Global/Foreign Index Funds to Pick?
There are several passive funds focusing on different countries that are being launched. First things first, you don’t need to invest in all the funds of different countries/geographies. And you need to be careful as, this time, there is a lot more focus on international schemes than domestic ones.
Most investors only need 1-2 international funds. That too, having a US-based fund would be good enough. The US is a good enough representative of developed markets. If you are an aggressive investor who knows what you are is getting into, only then must you invest in funds focusing on other international markets.
What about Sectoral/Focused Index Funds?
A lot of funds are being launched that have unique and innovative themes like EVs, international RE, even blockchain-based offerings!
But in my view, most investors don’t need to invest in narrowly focused themes and their funds. Even if these track some obscure narrow index outside India. Just because something sounds exotic, it doesn’t mean you should invest in it. Such funds are best (and only) suited for sophisticated investors.
As an investment advisor, I am seeing a small but growing interest among many to build a passive-only MF/ETF portfolio. And there are merits to it. Simplicity, less churning so less taxation, low expenses among a few more.
Having passive large-cap index funds is a great idea for the core of the portfolio. But after that, one can opt for active funds where one believes the fund manager can deliver alpha consistently.So, in my view, a good MF portfolio should be built based on active as well as passive strategies, though there is absolutely nothing wrong with being passive-only.
