Over the past few years, globally and in India, there has been a significant shift from actively managed funds to passive funds i.e. Index funds or ETFs. The rationale for the shift is that the USP of actively managed funds, which is outperforming the comparison benchmark, is not happening. In that case, there is no logic to pay the relatively higher expenses charged by actively-managed funds. Cheaper funds, with index-hugging performance, is good enough.
To look at some relevant data points, in the US, as of March 2020, passive funds accounted for 41% of combined U.S. MF and ETF assets under management (AUM), up from 3% in 1995 and 14% in 2005 (source: Federal Reserve Bank of Boston report dated 15 May 2020). This shift in MFs and ETFs has occurred across asset classes: passive funds made up 48% of the AUM in equity funds and 30% for bond funds as of March 2020, whereas both shares were less than 5% in 1995. As on the same date, U.S. stocks held in passive MFs and ETFs accounted for about 14% of the US equity market, up from less than 4% in 2005.
With this backdrop, let us focus on India. Till the middle of calendar year 2020, as per a report by SPIVA (S&P Indices versus Active), S&P BSE 100 index delivered a 3-year CAGR of 3.13%, 5-year CAGR of 5.6% and 10-year CAGR of 8.13%. Though these are prior to the bull run we are witnessing now, let us look at the comparison as on that date. As per the report, the performance of Indian equity-oriented funds in large-cap category over 3 years is 1.31%, over 5 years it is a CAGR of 4.63% and over 10 years it is a CAGR of 7.98%. That is, the index has out-performed the average of the large cap basket of mutual funds. Moving on to a larger basket, the 3-year, 5-year and 10-year annualized returns from S&P BSE 200 index was 2.89%, 5.83% and 8.32% respectively. Taking the average of the ELSS basket for comparison, the corresponding numbers are 0.29%, 4.98% and 9.22% respectively.
The common aspect between these two sets of data is that longer the time period under comparison i.e. 5-year over 3-year and 10-year over 5-year, the performance of actively-managed funds is better. The implication is, passive funds have done better over the last 3 or 5 years, and if we go back to longer history, active funds have done better. The inference holds true for another basket as well: S&P BSE 400 Mid-Small-Cap Index has delivered CAGR of -4.28%, 4.36% and 7.12% over 3, 5 and 10 years respectively. The corresponding numbers for Mid/Small cap funds are -2.65%, 4.69% and 10.2% respectively.
The additional inference from the last set of data is that outperformance of passive over active is pronounced in relatively larger market cap stocks i.e. BSE 100 and 200, but in mid and small caps, active funds have done better. Where the stocks are well-discovered by the market and the universe for the fund manager to play with is limited, passive ones have done better. Where the universe is larger and there are under-researched stocks, fund managers have done better.
Let’s take another perspective to the performance comparison: we look at calendar year performance over last six years, CY2020 to CY2015.We have compared large cap category average with Nifty100 TRI, mid cap category with Nifty Midcap150 TRI and small cap with Nifty Small-cap 100 TRI. We observe that active large caps have underperformed 5 out of 6 years, mid cap has underperformed in 4 out 6 but active small caps have out-performed the index in 5 out of 6 years. It is advisable for investors, to save on fund management expenses, to opt for Index funds or ETFs, in large cap or relatively-larger-cap stocks and expect fund manager outperformance in the small to mid-cap space.
Now let’s look at the AUM shift in the Indian mutual fund space. We take the passive space as the combined AUM of equity Index funds and ETFs, data source AMFI. As of December 2018, the AUM of “other ETFs” i.e. other than gold ETFs as per AMFI classification was Rs 1.07 lakh crore. As on that date, AUM in actively managed equity funds plus ELSS funds was Rs 7.87 lakh crore. As a percentage, it works out to 13.6%. Moving on by one year, as on December 2019, ETFs and Index funds had AUM of Rs 1.74 lakh crore. Corresponding AUM in equity funds was Rs 7.63 lakh crore. Hence over the year, passive went up to 22.8%. Now let’s look at the current situation. As of November 2020, the AUM of passive was Rs 2.4 lakh crore against active equity of Rs 8.3 lakh crore. That is, 28.9%.
In the current market context, passive looks better in the relatively-large-cap space and active looks better in the relatively-smaller-cap space where there is a wider canvas for the fund manager. Investors can take decisions accordingly.
(The writer is a corporate trainer (debt markets) and an author.)