Mutual Funds

How Passive Funds Help Diversify

Passive funds provide a simple way to invest in broad markets as well as in specific themes and sectors, making them ideal for an investor’s satellite portfolio

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How Passive Funds Help Diversify
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In recent years, investing in passive funds has gained a considerable momentum in India, aligning with global trends. While actively managed funds continue to form the backbone of many portfolios, passive strategies—particularly exchange-traded funds (ETFs) and index funds—are increasingly being recognised for their simplicity, cost-efficiency, and transparency.

A unique advantage of passive funds is their ability to provide not only broad market exposure, but also access to niche sectors and thematic investments, such as electric vehicles (EVs), defence, power, and other emerging trends.

These funds allow investors to gain targeted exposure to specific industries or themes without the complexities and risks associated with active stock selection.

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According to data from the Association of Mutual Funds in India (Amfi), as of September 2024, the total assets under management (AUM) of passive funds surged to Rs 11.2 lakh crore, marking an impressive 45 per cent growth year-on-year (y-o-y).

ETFs are the primary driver of this growth, contributing Rs 8.5 lakh crore, which accounts for 76 per cent of the total passive AUM. Retail participation in ETFs has also risen to 20.3 million folios as of September 2024. Index funds are also gaining traction, with Rs 2.7 lakh crore in AUM contributed by 8.7 million folios.

Appeal of Passive Investing

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The growing popularity of passive investing is driven by its simplicity and focus on replicating, and not outperforming market indices.

ETFs and index funds provide a straightforward way for investors to participate in market growth without the complexity of selecting specific stocks, which typically results in lower costs due to reduced active management.

While tracking error—deviation from the benchmark—has been a challenge, recent technological advances are minimising this.

High-frequency rebalancing algorithms, enhanced data analytics, and real-time monitoring are helping fund managers to keep portfolios closely aligned with indices, thereby offering a more accurate and cost-effective market replication with fewer discrepancies.

Balancing Strategies

It’s important to recognise that passive investing complements, rather than replace active strategies. A well-diversified portfolio that combines both active and passive approaches allows investors to manage risk effectively while also capitalising on growth potential.

Passive funds provide a simple way to invest in broad markets as well as in specific themes and sectors, making them ideal for an investor’s satellite portfolio. By keeping 70-80 per cent of their core portfolio in actively-managed funds and using passive funds for targeted exposure, investors can enhance diversification, tap into market trends, and maintain stability.

In India, where investors have varied needs and goals, this blended strategy is important for effective portfolio management. Given the advantages that passive funds offer, financial advisors can play a key role in building well-rounded portfolios by including them into asset allocation strategies.

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To maximise their effectiveness, passive strategies should be integrated into a well-diversified plan in alignment with the investor’s financial goals.

By Varun Gupta, CEO, Groww Asset Management

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