Should You Invest In Passive Funds?

Today, there is growing consensus among experts that with the announcements of new norms on categorisation of funds, and the introduction of total return indices (TRI) as the benchmark that fund managers must use to showcase their performance, active fund managers will find it increasingly difficult to outperform their indices by a considerable margin.

- Sudipta Mitu

This will especially be the case in the large-cap category. Therefore, it would make sense for investors to begin to look at low-cost, passive funds, at least in the large-cap category, if not all across their portfolio.

The impact of recategorisation of funds by the Securities and Exchange Board of India (SEBI) will be felt especially on the large cap category. Earlier, large cap funds invested in at least the top 200 stocks by market capitalisation. Under the new norms, they will have to stick to the top 100. Moreover, now 85per cent of the portfolio must be invested in large-cap stocks. Earlier, some large cap funds would have 70 per cent allocation to large-cap stocks, while others would have 75 or 80 per cent allocation. By raising their exposure to midand small-cap stocks, especially in rising markets, fund managers were able to show out performance over their peers. But now that leeway is gone, and with it, experts fear, the level of out performance of these funds may also come down.

The introduction of the Total Return Index will also have a significant impact. Earlier, funds were benchmarked against the Price Return Index, which took into account only the capital gains and losses of the constituent stocks. The total return index takes into account both capital gains and losses and the dividend yield. Once you add the dividend yield, a benchmark’s return improve, making it harder to beat. In the large-cap category, stocks give an average dividend yield of around 1.6 per cent. This means that if in past a price return index-based benchmark showed a return of 11 per cent, now it will show a return of 12.6 per cent.