The fourth episode of Smartly Passive: Unlocking the World of ETFs, presented by ICICI ETF and CNBC TV18, took viewers on an insightful journey into the realm of passive investing, a strategy that has been gaining momentum globally and in India. The episode featured experts Tarun Birani, Founder and CEO of TBNG Capital Advisors, and Deepak Shenoy, CEO of Capitalmind, sharing their perspectives on the benefits, types, and strategies of passive investing.
The Growth of Passive Investing
There has been a remarkable growth in popularity of passive investing, particularly through ETFs (Exchange-Traded Funds). Tarun Birani highlighted a significant global trend: assets under management (AUM) in ETFs have surged from $2 trillion in 2004 to an impressive $12 trillion today. This dramatic growth is fueled by the simplicity, cost-efficiency, and effectiveness of passive strategies in building diversified portfolios. “India is catching up with this global trend,” he noted, emphasizing that more investors and institutions are waking up to the advantages of passive investing.
Deepak Shenoy added his perspective, explaining how passive strategies, especially ETFs, are becoming increasingly attractive to large institutions like the Employees’ Provident Fund Organisation (EPFO). For these organizations, passive investing offers a straightforward, cost-effective way to gain market exposure without the need for extensive management.
“ETFs provide a low-cost, efficient way to mirror market returns, making them ideal for institutions that want broad exposure without the complexity,” Deepak Shenoy pointed out. He also highlighted that the SBI Nifty Index Fund, with around ₹2 lakh crores in assets, is now the largest mutual fund in India—a clear sign of the growing acceptance of index funds among both institutional and retail investors.
Different Types of Passive Investments
The episode delved into different types of passive investments:
- ETFs: Like stocks, ETF trades require a brokerage account. They offer intraday trading and lower costs but are limited by the index they track. Investors should be mindful of trading fees and liquidity.
- Index Funds: These funds replicate a specific index and are favoured for their simplicity and ease of access, offering straightforward market exposure.
- Direct Investing: Though not common in India, this involves directly buying stocks within an index, offering tax benefits and portfolio optimization.
- Target Date Funds: Designed for specific financial goals, like retirement, these funds adjust asset allocation as the target date nears and are expected to grow in popularity in India.
- Smart Beta Funds: These funds combine passive investing with active management, focusing on factors like momentum or value, allowing investors to customise their portfolios based on risk preferences.
Liquidity, Costs, and Tax Efficiency
One of the key differences between ETFs and index funds is liquidity. Tarun Birani explained that ETFs offer instant liquidity through intraday trading, whereas index funds provide liquidity once a day, based on the end-of-day NAV. However, not all ETFs are equally liquid, especially in the Indian market; some may have wider bid-ask spreads which potentially affects returns.
Deepak Shenoy discussed the cost structures of passive investments, noting that even with a low expense ratio, index funds might trail the index by 0.25% to 0.75% annually due to operational costs, such as the Securities Transaction Tax (STT). In contrast, ETFs tend to have lower tracking differences because they work with market makers who handle the trading of the underlying stocks, thereby reducing the impact of transaction costs.
Regarding tax efficiency, both experts agreed that there is not much difference between ETFs and Index funds in India, as both are subject to the same tax rules. However, they emphasized that other factors, such as investment suitability and overall strategy, should be considered when choosing between these options.
Building a diversified portfolio
The episode concluded with a discussion on diversification in passive investing. The experts stressed the importance of genuine diversification, where investors hold a variety of sectors and stocks that do not overlap significantly. He observed that many portfolios are over-diversified with similar types of funds, which can dilute the benefits of diversification. They recommended building a core portfolio that includes a mix of large-cap, mid-cap, and small-cap index funds, complemented by a satellite portfolio of factor-oriented strategies, such as smart beta funds. This approach allows investors to achieve broad market exposure while also targeting specific investment themes like momentum, quality, or value.
(Note: This is a partnered post)