1. Is India primed for the Passive Investing onslaught?

2. Post GFC: 8 Great years for Passive Funds in US

3. Are we about to witness a similar trend in India Let us first take a look at the evolution of passive funds in the US

4. Post 2008: Relentless march of Passive Investing
Post 2008: Relentless march of Passive Investing ...But 35 years after the launch of the first Vanguard fund
2008 GFC
Dot Com bust
Households’ net purchases of fund shares exceed those of corporate stock
The Revenue Act of (k)plans. Universal IRAs for all workers
First ETFs are issued
Investment Company Act of 1940
Vangaud started the first index fund
Source: Investment Company Institute Factbook

5. Outperformance of Passive funds over the average active fund has fuelled the rally
Money has consistently flooded into Passive funds from active over the last 10 years and not without reason
Most actively managed fund returns have been trailing the Vanguard 500 Index Fund

6. In India, active funds still account for bulk of AUM and inflows
Equity AUM of the Indian MF market is 4.75 lakh crore, out of which ~25,000 crore is in Passive (Index Funds + ETFs); incremental inflows seen in active funds
Mutual Funds in India have generally outperformed their benchmarks across categories over the last 5 years (For 3.6lakh cr of 3.75 lakh cr of Open End Diversified Equity AUM)
44 of 48 Large cap funds representing 98% of AUM have beaten NIFTY
82 of 86 Diversified Funds representing 97% of AUM have beaten BSE200
28 of 28 Mid Cap Funds have beaten NSE Mid Cap Index
Most of Equity AUM is held by retail investors though institutions like the EPFO have just begun entering the market through passive funds.
To further understand the reasons for such outperformance, lets compare the structure of S&P 500 with the NIFTY Index – the only investible benchmark in India
Total Equity AUM of 4.75 lakh cr. Arb AUM of 40Kcr, Close Ended AUM of 25kcr, Sector/Thematic AUM of 25kcr. Open end Diversified Equity AUM of 3.70lakh cr. Above analysis includes schemes with AUM of 3.6lakh cr.

7. NIFTY vs S&P 500: Stock Concentration
Source: Bloomberg
Source: Bloomberg
Due to higher concentration, Index returns are influenced to large extent by the top 20 stocks (75% NIFTY weight) in the Index. For S&P 500, top 20 stocks form only 38% of the index
Benchmark outperformance can be driven by active calls on the top 10 stocks due to their disproportionate weight.
Going outside the benchmark has been a key driver of outperformance for active investors.

8. NIFTY vs S&P 500: Free Float
Source: Bloomberg
Source: Bloomberg
Free Float factor for NIFTY Index is 53% vs 95% for S&P 500 Index.
Profit contribution of each sector doesn’t reflect the weight due to the free float factor
Infosys (4.5% of PAT but 6.0% of the Index) vs TCS (7.8% of PAT but 4.0% of NIFTY Index)
HDFC Bank (3.8% of PAT but 8.1% of Index) vs SBI (4.2% of PAT but 2.6% of Index)
Coal India (5.3% of PAT but only 1.25% of NIFTY Weight)
For Active Investing: Higher promoter holding is a positive. For Passive Investing: Higher free float is critical

9. NIFTY vs S&P 500: Depth
Source: Bloomberg
Source: Bloomberg
As per GICS classification, NIFTY covers only 22 distinct industries as compared to 61 covered by S&P 500.
Also, top 3 companies of the sector in NIFTY constitute over 2/3rd of the sector weight as compared to top 3 stocks in each sector constitute less than 1/3rd of the weight in S&P 500.
NIFTY as a benchmark represents only a small part of the economy and has concentration in few stocks & sectors.

10. Narrow indices not ideal for passive investing
In an emerging economy like India, new sectors emerge every decade. A narrow index, by its construct is at a disadvantage to capture these shifts at an early stage.
Span of industry coverage is limited in a narrow index.
Concentration, stock as well as sector, in a narrow index more pronounced.
Would a broader index satisfy the needs of passive investing?

11. NSE500 Index: A Viable Alternative?
NSE500 is a broader index as compared to NIFTY but still more concentrated than S&P500.
It covers 55 industries as compared to 22 for NIFTY
But is it investible??
Source: Bloomberg

12. Inevitability: NSE500 not there yet
Most broader indices like NSE500 don’t have index futures for hedging
192 stocks in NSE500 are covered by less than 5 analysts as compared to 8 in S&P500
Only 113 stocks in NSE500 are such that the value of their market capitalization gets traded annually as opposed to 485 in S&P500
There are 210 stocks in NSE500 for which the monthly traded volume is less than 6 million shares which is the volume of the least traded share in S&P 500.
There are only ~150 stocks in India which have traded futures which help price discovery and hence make market efficient
Source: Bloomberg

13. Are we putting the cart before the horse?
India is still an emerging market where new sectors emerge every decade.
Broader indices yet don’t have sufficient liquidity to be investible in terms of a passive strategy
Promoter driven companies give the active investor the edge to bet on promoter ability
Coverage of most analysts is limited to top 200 stocks resulting in lack of pricing discovery in the rest.
In US, passive investing has emerged mainly due to higher proportion of institutional investors, coupled with lower Alpha of the average active fund over the benchmark

14. Like any inevitable change, it is not a question of ‘if’ but ‘when’.
India too should see the wave of passive investing but only after
More representative indices are designed Markets mature to a level that is closer to developed markets
Alpha of the average active fund over the benchmark reduces
Emergence of large institutional investors looking to gain only Beta exposure
Like any inevitable change, it is not a question of ‘if’ but ‘when’.
Passive investing may be the future but that future is probably years away and not 3-5 years.

15. THANK YOU