India’s passive investing markets is growing at a healthy pace with total asset under management now at Rs 5.01 lakh crore making up 14% of industry, said Koel Ghosh, Head-South Asia S&P Dow Jones Indices and CEO, AIPL, A SPDJI and BSE Ltd JV. In an interview with Kshitij Bhargava of FinancialExpress.com, the S&P Dow Jones South Asian head shed light on what passive investment strategies domestic investors were opting for under the current market scenario and also talked about what’s driving the underperformance in largecap active funds. Here are the edited excerpts.
The passive AUM globally is massive – do we see a similar trend with the Indian ETF Market?
As of June 2022, the net assets under management for the Indian passive industry was 5.01 lakh crores with 229 products which is 14% of the industry size. The Global passive assets under management are at USD8.8 trillion with over 10,000 products. This is a decrease from the previous month and December 2021 numbers for the global assets. The Indian passive market, on the contrary, has had an optimistic growth of 12% year to date from Rs 4.48 lakh crores in December 2021 with 184 products. The year 2021 witnessed a growth of nearly 57% in assets which were Rs 2.85 lakh crore with 137 products in December 2020. The share of passive assets as a part of the industry total has witnessed the incline from 9% in December 2020 to 12% in December 2021 to now at 14% in June 2022. The statistics aptly depict the fast-paced growth of the passive space in India.
As we are witnessing extremely volatile markets in the last year – has this pushed market participants to look at investment strategies that mitigate risk?
Market conditions are dynamic and hence the strength and merits of passive investment have been recognized which have fueled its growth. The access to a basket of stocks instead of single stock exposure allows for diversification both at the stock and sector level balancing risk reward ratio. Additionally, index investing offers a transparent methodology which provides a clear view of the index properties and design. With low cost and traceability as added benefits, passive investing is an attractive proposition in all market conditions Diversification has been a key strategy for market participants and in India, we are seeing country-level diversification which has led to two-fold growth in assets in Fund of Fund investing overseas since 2020.
82% of Indian Equity Large Cap funds have underperformed their benchmark in the five-year period ending December 2021. What factors are driving this change and underperformance?
The evidence that most active portfolio managers typically underperform passive benchmarks appropriate to their investment style is extensive — both historically and geographically which has been well demonstrated in the SPIVA Scorecard. The underperformance of Indian Large Cap funds has been a recurring feature in the past few Scorecards but we see a new trend since the last scorecard. The shift in the mid-small cap category is worth taking note of where the active funds underperforming the index has surfaced in the 1yr, 5yr and 10year categories. Markets from time to time may undergo periods of heightened volatility. Active managers tailor risk exposures of their portfolios based on their assessment of evolving market conditions. An active fund may outperform or underperform its underlying index which may be linked to the active manager’s investing style. A market participant may look to mitigate this risk by choosing to invest through a passive route.
How are asset managers innovating their strategies to ensure they are evolving with market demands?
As an independent index provider, we do not manage assets ourselves, but what we are seeing in the market is that asset managers are increasingly including passive portfolios as a part of their overall offerings. The initial interest in market beta strategies has now expanded to include factor-based solutions which have significantly risen in the past decade. In general, factor investing refers to an approach that targets stock characteristics that drive the difference in expected returns over the long term. As of March 31, 2022, factor ETFs managed about USD 1.6 trillion assets globally, a 24.6% CAGR compared with the USD 178 billion 10 years ago. There is a wide range of factor indices but some of the popular ones are Dividend, Low Vol, Momentum, Quality and Value. We have also seen the launch of passive products on international indices giving market participants international exposure as a new investment strategy.
How much interest are market participants showing in smart beta strategies such as dividend and low volatility considering the recent range-bound movement in domestic as well as global stock markets?
The low volatility strategy tends to perform well in bear markets thanks to its defensive nature while lagging during bull markets. The momentum factor implies that stocks that have performed well in the past compared with their peers tend to continue to perform well in the coming near term, and vice versa. The quality factor is measured via profitability, earnings stability and financial leverage. The idea of the quality factor is to identify companies with high profitability, a strong balance sheet and low financial leverage. Those companies tend to manage capital effectively and be able to generate robust cash flow in the long run. The value factor is probably one of the most well-documented and studied factors in the investment industry. It refers to the idea that companies with lower valuations tend to generate higher expected returns relative to companies with higher valuations.
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Based on a latest research paper we have observed that low volatility, momentum and quality factors have worked well in the Indian market over the 17 years since 2005, while the value factor underperformed the market. The value factor had negative correlations against the other three factors.
Quality and low volatility factors tended to be more defensive, while the dividend, value, and size factors displayed procyclical characteristics. Single-factor portfolios could potentially act as tools for the implementation of active views, or alternatively, they could be blended in multifactor portfolios that aim to deliver smoother excess return across business and market cycles.
Different market regimes support different strategies and Indian product providers are steering towards offering the factor basket in the passive space after the market beta has been in play for a while.