The dynamics of passive investing have changed significantly in the last few years in India. With the proliferation of awareness initiatives and the introduction of innovative benchmark schemes by mutual fund houses, investors are exploring the passive universe with active interest.

Riding on the back of strong demand, data released by Finity Report projects that the assets under management (AUM) of passive funds are expected to cross Rs 25 lakh crore by March 2025.

The report further expects passive assets to comprise nearly 37 per cent of the overall assets in the Indian mutual fund industry by March 2025 against 10 per cent in March 2021.

These figures are a clear indication of the exponential growth anticipated in the next few years as we expect passive and active funds to play complementary roles in an individual’s portfolio.

Even under passive schemes, index funds have been gaining popularity amongst investors and mutual fund houses alike.

Simply put, index funds replicate a stock market index in terms of a portfolio. For instance, if a mutual fund house were to launch a Nifty 50 Index Fund, it would have the same 50 stocks in its portfolio that are part of the Nifty 50 Index. Even the weightages of the stocks would mirror those in the index against which the scheme or the fund is benchmarked.

In addition to the fact that these funds tend to perform in unison with the benchmark index they track, there are a plethora of reasons that make index funds attractive to investors.

Broad market exposure

Based on the industry that they operate in and their full market capitalisation, companies in India are classified under various indexes on the BSE or NSE. Therefore, when an investor chooses to invest in a fund that tracks the BSE 500 Index or the Nifty 100 Index, he/she is invariably presented with a robust portfolio that is diversified across companies, sectors and market capitalisations.

The broader market exposure extends to fixed income indices as well that cover assets such as government securities, T-bills, corporate bonds and commercial papers.

Governed by the regulator to safeguard the best interests of the investors, these indices provide for a well-defined, market relevant and rules-based framework.

Lower expense ratio

One of the key reasons for the growing popularity of index funds is the lower expense ratio. Since the underlying securities in the portfolio replicate the benchmark that it tracks, the fund manager is not actively involved in buying/selling securities.

Consequently, index funds have lower fees and operating expenses than actively managed funds. Given the current macroeconomic situation, the fund manager’s quandary to select the right growth and quality-focused companies to invest in has probably increased tenfold.

Index funds, on the other hand, leverage market wisdom by following an automated and well-regulated investment method that is free from human or emotional bias.

Transparency at the core

With the ongoing volatility in the environment, investors are looking for transparency and resilience in addition to capital appreciation potential in their investment portfolios.

Since index funds only allow for companies listed on a particular index to be a part of the portfolio, the investor knows the exact composition of the underlying assets in the fund.

There is no communication barrier. Not only does this help in promoting transparency but also makes it easier for the investor to understand and track his portfolio at all times.

Access to sectoral investing

The pandemic has been a testament to the fact that sectors such as healthcare, banking, consumption and technology will continue to thrive even in the face of adversity.

Investors who wish to be a part of the growth story of these sectors can invest in an index fund that track the banking index, consumption index, technology index. Since these funds leverage the broader market wisdom, they are also free from fund manager bias, ensuring exposure to all companies on the decided index.

Thematic innovation

No longer are index funds representative of traditional market benchmarks. A stronger regulatory focus to develop the investing landscape in India coupled with the emergence of global themes has opened the floodgates for single or multi-factor thematic investments such as cloud computing, electric vehicles and new economies. In fact, fund managers are increasingly eyeing themes that showcase the promise of future sustainability and growth.

We are also witnessing the emergence of Smart Beta Index Funds that are creating innovative ‘factor-based’ indices and enabling a more structured identification of companies for an investor.

Index funds have the potential to lay a strong foundation for an investor’s wealth creation journey. In the future, one may also witness more innovations to the benchmarks, allowing investors to leverage hitherto unknown opportunities in the market.

The writer is head of products and alternatives, Axis AMC

Target maturity

What are target maturity funds and how do they work? Are there any risks to investing in these funds?

J. Dutta, Calcutta

Target maturity funds, recently in vogue, are open-ended debt funds that have a specific maturity date. They are similar in nature to fixed maturity plans but unlike FMPs which are closed-ended, these funds are open-ended, which means that the investor can exit at their discretion keeping in mind the tax implications on redemption. The funds invest in bonds which are issued by PSUs and corporates with good credibility and the underlying bonds are mostly AAA rated. These funds are based on a benchmark. These are preferred by investors who are looking for less volatility in returns over a given period. With interest rates on an upward trajectory, these funds will allow the investor to lock in a high yield over the tenure of the fund. However, there is a risk when the interest rates are trending downwards.

NPS contribution

Can a central government employee continue to contribute to the NPS beyond 60 years or the age of superannuation?

J. Sur, Calcutta

According to the updated FAQ (August 30) from PFRDA, a subscriber has the option to contribute to the retirement account till 75 years of age. However, the account will be shifted from the ‘government’ to the ‘all citizens including corporate’ sector and expenses, maintenance charges and fees payable under NPS will continue to remain applicable. The subscriber has to exercise the option at least 15 days before he turns 60 or his age of superannuation, intimating his preference in writing to the CRA or the NPS Trust. The subscriber can exit at any point during the extended period by submitting a request to the CRA or NPS Trust.

If you have any queries about investing or taxes or a high-cost purchase, mail to: btgraph@abp.in, or write to: Business Telegraph, 6 Prafulla Sarkar Street, Calcutta 700 001.