Passive Investing Through ETFs: A Prudent Strategy for Long-Term Wealth Building

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Passive investing has been a notable trend in India in recent years. Also known as index investing or passive management, passive investing is a strategy where the Scheme seeks to replicate the performance of a specific market index, such as Nifty 50 or S&P BSE Sensex, by investing in a portfolio of securities that mirror the composition of the underlying index.

Unlike active investing, where fund managers aim to outperform the market by actively picking and choosing stocks, passive investing follows a “set it and forget it” approach.

The approach is based on the efficient market hypothesis, which suggests that it is challenging to consistently outperform the market. Instead of trying to beat the market, passive investors aim to capture overall market returns by investing in a broad range of companies. This approach eliminates the need for constant monitoring and trading, making it an attractive option for both experienced and novice investors.

Why Passive Investing Is Picking Up Pace In India

The National Stock Exchange of India in June 2023 said that the assets under management (AUM) of passive funds, such as ETFs and index funds that track Nifty indices, crossed the landmark Rs 5 lakh crore figure. The AUM of passive funds has seen a phenomenal increase, from Rs 80,755 crore in March 2018 to Rs 674,783 crore as of March 31, 2023.

Over the past five years, passive funds’ AUM recorded an annualised growth rate of 53%. In the same period, the number of passive funds available in India has risen from less than 100 to almost 350.

Unsurprisingly, passive investing has gained traction in India due to its simplicity, cost-effectiveness and potential to outperform actively managed schemes over the long term. It offers a number of advantages, including lower expense ratios compared to active schemes, diversification by investing in a broad market index, transparency, reduced portfolio turnover, and tax efficiency due to lower turnover rates.

Another factor contributing to the growth of passive investing is the availability of ETFs that allow investors to easily access a wide range of market indices. These schemes have gained popularity due to their relatively lower expense ratios and ease of trading. As a result, more and more investors are choosing to invest in ETFs as part of their strategy.

ETFs: An Important Tool For Passive Investing

ETFs are one of the primary investment vehicles for passive investing. ETFs are investment schemes that trade on stock exchanges, similar to individual stocks. They are designed to track the performance of a specific index, sector, commodity or asset class. ETFs offer investors the opportunity to gain exposure to a diversified portfolio of stocks without having to purchase each individual security.

Unlike other Mutual Fund schemes, ETFs are priced throughout the trading day and can be bought and sold at market prices. This flexibility allows investors to take advantage of market fluctuations and adjust their positions accordingly.

Over the past decade, the popularity of ETFs in India has been on the rise, with their growth rate surpassing that of the overall mutual fund industry for most years. Total AUM in ETFs in India has risen to Rs 6.5 lakh crore, accounting for around 13% share of total mutual fund AUM. Significant growth is expected in the ETF segment in the future due to a range of benefits they offer.

Advantages Of Investing In ETFs

• Diversification: One of the key benefits of ETFs is instant diversification. By investing in an ETF, investors gain exposure to a wide range of securities, reducing the risk associated with investing in a single stock. This diversification spreads the risk across different companies and industries, providing a level of stability to the portfolio.

• Cost-Effectiveness: ETFs are known for their relatively lower expense ratios. These funds are designed to passively track an index, which means they require less active management. As a result, the expenses associated with ETFs are significantly lower.

• Trading Flexibility: These schemes can be bought and sold throughout the trading day. Unlike other Mutual Fund schemes, which are priced at the end of the trading day, ETFs offer real-time pricing.

• Transparency: ETFs provide transparent holdings information, allowing investors to see exactly what securities the scheme holds. This transparency enables investors to make informed decisions.

• Tax Efficiency: These schemes are structured in a way that minimises capital gains distributions, making them more tax efficient. ETFs are created and redeemed in large blocks called creation units, which helps to minimise taxable events.

Types Of ETFs

• Equity ETFs: These ETFs track an equity index, such as the Nifty 50, S&P BSE Sensex, Nifty 100, etc. They provide investors with exposure to a broad range of stocks across different sectors. Now there are also ETF that focus on tracking indices that invests in specific industries, such as banking, technology or healthcare, allowing investors to gain targeted exposure to a particular sector or industry which they expect to boom. Some indices include Nifty Bank Index, Nifty Infrastructure, etc.

• Debt ETFs: These ETFs track an index that allow investors to gain exposure to a basket of debt securities, such as government bonds, corporate bonds, debentures and money market instruments. 

• Commodity ETFs: These ETFs enable investors to gain exposure to a range of commodities, such as gold, agricultural products and natural resources like oil, without having to directly own the physical assets. Gold ETFs are popular among investors looking to diversify their portfolios and hedge against inflation.

Passive Investing Through ETFs: A Smart Investment Strategy

If you are looking for a tool to passively grow your wealth in the market, ETFs can be the perfect answer. These schemes offer a range of benefits that can make them an attractive investment option for both seasoned and beginner investors.

By selecting ETFs that align with your investment goals and risk tolerance, you can diversify your portfolio, reduce costs and gain exposure to specific sectors. ETFs can thus offer a smart edge to your investment strategy.

Sources: www.nseindia.com; www.niftyindices.com; Nifty Passive Insights Report by NSE Indices.

Mutual Fund investments are subject to market risks, read all scheme related documents carefully.