The Indian mutual fund industry has come a long way since its inception, witnessing a significant transformation in terms of product offerings and investor preferences. Initially, the mutual funds industry focus was primarily on actively managed funds, where fund managers actively select stocks or bonds based on their expertise and market analysis. However, in recent years, there has been a growing interest in passive investment strategies, which involve investing in funds that track specific benchmark indices, such as the Nifty 50 or Sensex, as well as broader and sectoral indices.
Investor’s faith in the potential of passive funds India is rising and this has given rise to demand for newer index funds and ETFs (Exchange Traded Funds). However, with the rising demand for new passive investment India avenues, there have also been expectations around the introduction of newer categories of passive funds India.
Check this blog to learn about the newer indices launched by the Bombay Stock Exchange (BSE) in India over the last few weeks.
Introducing Newer Categories: FoFs, Smart Beta, and Passive ELSS
In line with the evolving landscape, the Indian mutual fund industry has seen the introduction of newer categories of passive funds viz, Fund of Funds (introduced in early 2000s), Smart Beta Funds (launched in mid 2010s) and Passive ELSS (only recently launched in 2024).
1. Fund of Funds (FoFs)
FoFs are mutual funds types that invest in other mutual funds, typically index funds or Exchange Traded Funds (ETFs). This approach can allow investors to diversify their portfolios across different asset classes and fund managers without the need for extensive research. Also, it gives the double-passive effect to your passive investment India choices.
2. Smart Beta Funds
This can be treated as passive funds India with a hint of active style. Unlike traditional index funds that track a market-cap weighted index, smart beta funds use alternative weighting methodologies to capture specific market factors or investment strategies. These funds aim to provide enhanced returns by focusing on factors such as quality, value, or momentum.
3. Passive ELSS Funds
Gone are the days of plain vanilla ELSS funds that were only actively managed. Passive ELSS funds are equity-linked savings schemes (ELSS) that follow a passive investment strategy. ELSS funds offer tax benefits under Section 80C of the Income Tax Act, making them popular among Indian investors.
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How These Funds Work
A. Funds of Funds
FoFs typically invest in a basket of index funds or ETFs. The fund manager selects these underlying funds based on their investment objectives, risk tolerance, and market conditions. Investors benefit from the expertise and diversification provided by the fund manager.
Why Invest in FoFs
1. Diversification
FoFs provide a diversified portfolio by investing in multiple funds across different asset classes and fund managers.
2. Professional Management
Fund managers with expertise in selecting and managing underlying funds can help investors make informed decisions.
3. Accessibility
These funds can provide investors with accessibility to international mutual funds and ETFs. Furthermore, FoFs offer investors access to a wide range of investment opportunities, including international markets and niche sectors. They can also be called as the gateway to investing in international mutual funds in India.
Check out different FoFs at the Kuvera portal.
B. Smart Beta Funds
These funds employ different weighting methodologies to construct their portfolios. For example, a quality-focused smart beta fund may assign higher weights to companies with strong financial metrics, while a value-focused fund may prioritise undervalued stocks.
Why Invest in Smart Beta Funds
1. Enhanced Returns
Smart beta funds aim to capture specific market factors or investment strategies, potentially leading to higher returns compared to traditional index funds.
2. Reduced Tracking Error
By using alternative weighting methodologies, smart beta funds may have lower tracking error compared to traditional index funds.
3. Targeted Exposure
Investors can choose smart beta funds that focus on specific factors such as quality, value, or momentum, aligning with their investment preferences.
4. Passive ELSS Funds
Similar to traditional ELSS funds, passive ELSS funds invest in a diversified portfolio of equity securities. However, they use a passive investment approach, tracking a specific index.
Why Invest in Passive ELSS Funds
1. Tax Benefits
Passive ELSS funds offer tax benefits under Section 80C of the Income Tax Act, allowing investors to reduce their taxable income.
2. Low-Cost Investment
Passive ELSS funds typically have lower expense ratios compared to actively managed ELSS funds.
3. Diversification
These funds invest in a diversified portfolio of equity securities, reducing investment risk.
Difference between Newer Category Passive Funds India and Other Mutual Funds
Here is a table explaining each of these categories and their difference from other mutual funds:
| Feature | Passive Funds (FoFs, Smart Beta, Passive ELSS) | Other Mutual Funds |
|---|---|---|
| Investment Strategy | Tracks a specific index or follows a defined investment strategy | Actively managed by fund managers who select individual securities based on their analysis and research |
| Expense Ratio | Generally lower than actively managed funds due to the passive nature of their investment strategy | Typically higher than passive funds due to the active management involved |
| Returns | Aim to match the performance of the underlying index or benchmark, minus the fund's expense ratio | Seek to outperform the benchmark by actively identifying undervalued or overvalued securities |
| Risk | Lower risk compared to actively managed funds as they track a diversified index or follow a defined strategy | May have higher risk due to the active stock picking and potential for individual stock performance to deviate from the overall market |
| Tax Benefits | Passive ELSS funds offer tax benefits under Section 80C of the Income Tax Act | May offer tax benefits depending on the fund type and investment horizon |
| Suitability | Ideal for investors who believe in the long-term performance of the market and prefer a low-cost, hands-off approach | Suitable for investors who are comfortable with the risks associated with active management and believe in the fund manager's ability to outperform the market |
Wrapping Up
The Indian mutual fund industry has witnessed a significant shift towards passive investment India strategies. FoFs, smart beta funds, and passive ELSS funds can offer investors a diverse range of options to achieve their financial goals. By understanding how these passive funds India work and their key features, investors will be able make informed decisions about their investment portfolio.
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