Passive investing is gaining immense popularity all over the globe. During the last few years, passive funds have seen a tremendous growth in assets even here in India. As per AMFI September 2022 data, assets under management (AUM) in passive mutual fund schemes have multiplied by 3.6 times in the last 3 years (CAGR of 53%). As you may know ETF and Index funds are examples of passive funds offered by mutual funds India.

What are passive mutual funds?

Passive funds are mutual fund schemes which tracks and replicate the return of a benchmark index e.g. Nifty, Sensex etc. ETF or Index funds, which are passive mutual funds, do not aim to beat the index; instead they aim to replicate the performance of a benchmark index as closely as possible.

How are passive funds different from a typical equity fund?

Mutual fund investment in India are mostly actively managed. The fund manager of active mutual fund schemes tries to outperform the benchmark index by generating excess returns, known as alpha for investors.

ETF or passive funds, on the other hand, do not aim to beat the benchmark returns; they simply track the benchmark index. If you are investing in an exchange traded fund or any passive fund, you should be happy if you get the benchmark return subject to tracking error. Since ETF mutual fund or passive mutual funds do not need active management, the cost of these schemes, known as TER, is much lower than that of an active mutual fund.

Why should you invest in ETF?

Even though a good active mutual fund schemes may have the potential of generating higher returns compared to passive schemes like ETF, there are quite a few good reasons as to why should you consider having ETFs in your portfolio.

• In order to beat the benchmark index returns, the fund manager of an actively managed mutual fund has to be overweight / underweight on certain stocks. This gives rise to the unsystematic risk in the active mutual fund schemes. However, there is no unsystematic risk in ETF mutual fund as they replicate the performance of benchmark index subject to tracking errors. It means, an ETF, is only subject to market risk, whereas active mutual fund investments are subject to both market risk and unsystematic risks.
• The total expense ratio of ETF funds are much lower than those of the active funds. TERs get adjusted in the scheme mutual fund NAV or NAV and have direct impact on returns. In order to outperform a passive fund tracking the same benchmark index, an active fund will have to beat the benchmark by a margin higher than the difference in TERs of the two funds. For example, if the TER of an ETF and active mutual fund is 0.1% and 2% respectively, then the active fund will have to beat the benchmark return by more than 1.9% in order to outperform the exchange traded funds return.

ETF is a great investment option. You need to have Demat and share trading account with a stock broker to invest in exchange traded funds. You can buy or sell ETF mutual fund units in stock exchanges using your trading and demat account.