Goodwill  Investor Education Initiative :  GoodWill  Eagle’s Eyes!

Passive Mutual funds…An overview:

Passive Mutual funds normally track a market index to allow a fund to fetch maximum gains. Inactive funds the fund manager picks certain stocks based on their investment process and judgment of future prospects of the company. passive funds invest in stocks in line with the underlying index.

What are the options in the passive investment segment?

Passive funds could be in the form of either index funds or Exchange Traded Funds (ETFs).

Index funds are like any other mutual fund scheme that invests in the constituents of an underlying index in the same proportion as in the index. ETFs are index funds but listed on the stock exchange so that they can be bought and sold in real-time during market hours.

To cater to growing demand amongst different categories of investors, mutual funds and index providers have come up with many options across various segments of the markets, both in equity and fixed income.

Example:  if an investor is looking to park money in the broad market, there are index funds/ETFs like Nifty 50, Nifty Next 50, Sensex 30. If the requirement is to invest in the mid and small-cap space at a low cost, without going through the hassle of selecting individual stocks, there are market capitalization-based indices

How to invest in these funds?

Passive investors prefer Index Funds and ETFs. Individuals can invest either directly from the AMC’s website or through various digital or online platforms. Like any other mutual funds, they can invest in a lump sum amount or set up a SIP to systematically invest on a periodic basis.

In the case of ETFs, they can invest real-time during market hours. To buy/sell ETFs, an investor would require a trading account with a broker and a demat account to hold the ETFs.

The key factors to consider while investing in passive funds

Since the base of the passive fund’s portfolio will come from the index that it is tracking, it is very important to understand the logic of that index, the selection and elimination criteria of stocks, and risks involved in that strategy.

For retail or HNI investor who is looking to invest for the long term and is not concerned with intraday prices, index funds are a good option. An investor can do SIP in index funds but not in an ETF. There are certain entities that are not permitted as per their internal guidelines to have stockbroking and demat accounts. So, such entities can also invest in index funds.

The total cost of funds includes all expenses including brokerage and other taxes paid on buy and sell transactions on the stock exchange, annual demat account charges, bid/offer spread, etc. Suppose, an investor has Rs 100 to invest and his/her equity and debt allocation is 60:40. Of Rs 60, he/she can wish to invest Rs 50 in large-cap, then invest Rs 25 in an active fund and the remaining Rs 25 in a passive fund. Mid and small-cap allocation can be in active funds.

The risks associated with investing in passive funds

While passive investing eliminates a lot of risks that active funds hold – like fund manager bias and selection bias, it comes with its own set of risks.

It is important to keep in mind that market risk is applicable for both active wells as passive funds.

Even passive funds will fall when the overall markets are correct. A passive fund brings with it the risk of the underlying index it aims to track. So if, for example, the index fund is tracking the Nifty 50 Index, all the risks associated with the Nifty 50 Index such as downside risk of equity markets, volatility of stocks, etc. will apply to the fund as well.

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