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Investing in passive mutual funds is gaining traction in India
When investing in mutual funds, you can choose passive funds (which replicate existing indexes without the fund manager’s intervention); or active funds (where the fund manager decides where to invest).
While there are merits and demerits of both, investors often choose one side and become quite vocal supporters of the chosen side (on social media).
But without a doubt, passive investing is gaining a lot of traction in India now. This trend has already been there in developed markets for several years. Until a few years back, there were just a handful of passive options in India. But now, there are more than a hundred passive schemes.
So, if for some reason, you decide to go passive-only, then how can you build an all-passive mutual fund portfolio made up only of index funds? Let’s go market segmentwise:
Large-cap index funds
These are indexes that invest in the top 100 stocks by market cap. Most investors will do well to have some component of large-caps in their portfolio. The best option for them in the passive space is to choose a large-cap index fund that is based on Nifty50 / Sensex / Nifty100. Index funds based on these indices provide sufficiently diverse exposure to large-cap stocks.
Also, while Nifty Next50 also technically qualifies as a large-cap index (since it is part of the top 100 stocks by market cap as per SEBI definitions), in reality, it has all the characteristics (risk-return attributes) of the more volatile cousin mid-caps. So, if a little extra volatility is acceptable to the investor, then one can even consider the Nifty Next50 index fund in addition to larger ones based on Nifty50/ Sensex/ Nifty100.
Mid-cap index funds
Mid-caps are those stocks that are part of the market cap range bucket of 100-250. These are more volatile than the large caps but also have the potential for higher returns in the long run. In mid-caps, the available passive index options are Nifty Midcap150, Nifty Midcap50, and the factor-based Nifty Midcap150-Quality50.
Nowadays, there is a passive option that combines large-caps and mid-caps. This is the newly launched index of the Nifty LargeMidcap 250 index.
Small-cap index funds
The small caps have given amazing returns in the last few years and hence, these are darlings of many. Even in this space, there are passive options though active funds rule the roost. Nevertheless, in small caps, the available passive index options are Nifty Smallcap250, Nifty Smallcap50, and the factor-based Nifty Smallcap250-Quality50.
That was about the three core market cap categories and the available passive investment options.
Chip in active mid-caps and small-caps
But unlike large caps where nowadays the active fund managers are finding it difficult to beat the index TRI returns, the Indian mid-and-smallcap space is still not very efficient. As a result, good active fund managers in this space tend to do quite well compared to the indexes and generally beat them.
In my view, it would be a good idea for you to add to your portfolio some well-managed and proven active mid-cap and small-cap funds.
And what about other categories? What about sectoral/thematic index funds? In my view, most investors can skip sectoral/thematic funds altogether. Most people don’t have sectoral expertise to understand when to enter and exit such funds. So you had better avoid them and stick to broader, well-diversified indexes.
For exposure to stocks outside India, consider having a US-based S&P500 index fund (or a NASDAQ-based index fund if willing to take more risk and volatility). But with the RBI’s curbs, most of the funds are currently closed for subscription.
To build an all-passive portfolio, you don't need to go in for many funds. Just stick to 2-4 schemes and you can easily build a solid, low-cost, low maintenance pure passive mutual fund portfolio.
How much?
If you are looking at suggestions for equity funds in the passive fund, then here are a few possible combinations:
- 100% in Nifty50 index only
- 60-70% in Nifty50 index + 30-40% in Nifty Next50 index
- 50% in Nifty50 index + 25-30% in Nifty Next50 index + 20-25% in Nifty Midcap150 index.
(By arrangement with livemint.com)
