Passive investing is no longer just Nifty, Sensex; index choice matters as options multiply

According to fresh market updates, Passive investing may have started as a simple, low-cost way to track the market, but the proliferation of index funds and ETFs has made the choice of underlying index increasingly important for market participants.

Speaking at the Moneycontrol Mutual Fund Summit in Delhi, Pratik Oswal, Director, Motilal Oswal noted that passive investing now extends well beyond the Nifty 50 and Sensex, with products tracking sectors, commodities, international stocks and themes. “Passive is not just Nifty and Sensex anymore,” he stated.

The expansion has created a “problem of plenty”, with more than 700 passive funds, ETFs and index funds now available, Oswal stated. Motilal Oswal AMC itself runs around 75 such products. At the same time, he stated, investor needs have become more complex. While market participants earlier tended to seek broad categories such as large-cap, mid-cap or flexi-cap funds, portfolios have become more personalised, with market participants increasingly wanting to express views on particular sectors.

“Today, portfolio management has become extremely personal,” Oswal stated. Having noted thousands of portfolios, he stated he rarely comes across two that are alike.

With the passive universe expanding, Oswal stated market participants should not get carried away by the number of options and should instead focus on asset allocation. “Whether you buy an active fund or a passive fund or a dynamic fund, whatever type of fund out there, the key is always asset allocation,” he stated, adding that asset allocation becomes particularly important over a 15-20 year period.

Oswal additionally stated market participants should not assume that the passive label by itself makes a strategy preferable. “I'm a big believer of outperformance,” he stated.

He stated that while he oversees the index funds business, he stays focused on strategies that can deliver returns above the benchmark. Of the 35-40 unique fund indexes run by Motilal Oswal, he stated, barring two, all were outperforming the Nifty 50.

“There is a huge market for outperformance, whether it's active management or smart beta or sector or whatever it is,” he stated.

Thematic funds can be highly concentrated

The wider choice of passive products additionally means market participants need to understand the construction of the underlying index, particularly when considering thematic and sectoral funds. Responding to a question on whether concentration in a few stocks undermines the diversification argument for passive funds, Oswal stated market participants need to look at such products as part of their overall portfolio. Thematic and sector funds can be useful when an investor is bullish on a particular theme or sector but does not want to choose between individual stocks within it, he stated..

But such funds can be highly concentrated. Some themes may not have enough firms, while others can be dominated by a few large-cap stocks, with the rest of the index made up of smaller firms.

“So, yes, there is a very high concentration that market participants can expect,” he stated, adding that this is something market participants should watch out for when investing in thematic and sector funds.

Oswal stated diversification additionally has limits. In his view, 40-50 stocks provide optimum diversification, although he acknowledged that holding more stocks can provide additional diversification.

Thematic and sector funds are additionally highly cyclical, he stated. Market participants who use these products successfully tend to decline into two broad categories: those taking a tactical call over a shorter period and those willing to hold the exposure for a very long time.