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    Should you build a diversified portfolio with just passive mutual fund schemes?


    Experts say investors should not be lured by the low-cost structure of passive funds alone.

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    Investors should not stress over low-costs alone. There is no sense in going 100% into passive funds.
    Passively managed funds have been around for years. However, for investors, choice in these funds have been very limited till now. Existing passive funds mostly come in the form of frontline index-based offerings, restricting the utility of these funds. However, this is set to change with several new passive-based offerings targeting a much wider universe of stocks.

    Expanding the net
    Fund houses have lined up a slew of index-based funds that will invest in mid-caps, small-caps or across the spectrum. For instance, Motilal Oswal AMC has filed papers for Motilal Oswal Midcap 150 and Motilal Oswal Smallcap 250. These will track the indices comprising the corresponding universe of stocks. It is also planning to launch Motilal Oswal Nifty 500 based on the corresponding index. Reliance AMC, which launched Reliance ETF Nifty Midcap 150 earlier this year, is slated to launch a couple of Fund of Funds (FoF). One would be based on the same index. The other, Reliance Passive Flexi-cap, will invest in Reliance ETF Nifty Midcap 150 and Reliance ETF Nifty 100, and any other index offering of the fund house.

    These upcoming offerings open up a wider universe of stocks for passive investors— long restricted to the confines of the top 100 stocks by market capitalisation. As of today, investors cannot really build a truly diversified portfolio using passive funds. They have to rely on actively managed funds for taking exposure beyond the frontline stocks. Now, the new offerings will allow investors to harness passive investing across their portfolio. With passive funds extending their investible universe, investors will be able to to build a broader portfolio at a substantially lower cost.
    Things You should consider
    • Annualized Return
      for 3 year: 7.5%
    • Suggested Investment
      Horizon: >3 years
    • Time taken to double
      money: 8.0 Years
    Things You should consider
    • Annualized Return
      for : %
    • Suggested Investment
    • Time taken to double
      money: N.A

    Experts still batting for actively managed funds

    While large-cap funds have struggled, others have outperformed their benchmarks.

    Source: Value Research. Data as on 15 July. Indices considered for the respective categories are S&P BSE Sensex 50 TRI, S&P BSE Mid Cap TRI, NIFTY Smallcap 100 TRI and S&P BSE 500 TRI

    For instance, it will now be possible for investors to construct a 100% passive portfolio covering a mix of large-cap, mid- or small-cap and multi-cap oriented index funds or ETFs. Depending on your risk appetite and desired asset mix, you can allocate money to these passive funds in different proportions. Apart from this, there are passive offerings in both debt and gold, which allows for passive diversification across multiple asset classes. Besides, for investors seeking sector-based exposure, there are already a few banking sector ETFs, with few more in the pipeline. As more and more fund houses come up with wide-ranging passive products, investors will have multiple options to choose from.

    Amol Joshi, Founder, PlanRupee Investment Services, says, “Wider choice of funds in passive investing will allow investors room to manoeuvre the portfolio. As evidence emerges that outperformance is shrinking in active funds, investors will be able to shift to passive.”

    Are we there yet?
    The question now is, should you go entirely passive, even if it is doable? Does it make sense to abandon the active funds that currently form the bulwark of your portfolio? Actively managed funds charge much higher fees—expense ratio is up to 150-175 basis points higher—for generating alpha, or excess return, over the index. These fees are justified as long as the fund managers can deliver the alpha on a sustained basis. However, the fees start to pinch when the alpha diminishes or worse, disappears. Over the past few years, several large-cap and a few multi-cap funds have been found wanting.

    The excess returns, if any, have not justified the hefty fees charged. Large cap funds have clocked 10.7% and 9.9% annualised return over past three and five years respectively, even as Nifty 50 TRI has gained 12.63% and 10.9% during these periods. With a much lower cost structure, passively managed funds seek to deliver more value to investors. They simply promise to deliver returns in line with the chosen index, subject to a small tracking error. Also, unlike active funds, investors in passive funds do not have to worry if the fund manager exits, or if the funds’ investing style undergoes any changes.

    However, experts say active funds still offer better reward in the mid- and smallcap segments. Unlike large-cap funds, alpha generation remains healthy for mid- and small-cap funds. Mid-cap funds have delivered 12.07% annualised returns over the past five years compared to 11.1% uptick in the S&P BSE Mid Cap TRI.

    Vidya Bala, a mutual fund research expert, is not in favour of taking a pure passive approach. “Market-cap based indices are not nimble enough to capture opportunities in the broader market. Until indices are constructed more efficiently, the active fund universe beyond the large-cap space offers superior reward,” she says. Joshi insists investors should not stress over low costs alone. “There is no sense in going 100% into passive funds. Even at the higher cost, active funds from mid-, small- and multicap space are able to deliver higher returns after costs. Several large-cap funds also show outperformance over longer time frame,” he says.

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