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The Market Dynamics of Active vs Passive Investing

cnbctv18, Oct 20, 2020

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Wizards of Finance (a joint initiative by CNBCTV18.com and Mirae Asset Mutual Fund) is an investor education series that delves into interesting insights about choosing the right investments for different financial goals and increasing wealth during uncertain times.

Active vs Passive InvestingActive investment necessitates a fund manager to pick stocks that beat the market or the respective benchmarks. You must delve deeper into market insights to understand its integrities.

Passive investing, however, involves buying the market at the respective index to achieve market-specific returns subject to tracking error.

To understand market dynamism, it is necessary to understand both sides, map it to your profile’s risk suitability and accordingly make a move.

“Going forward, as the markets become more streamlined & efficient, the core side could become the passive side, and you can take tactical calls on the active side through fund managers”, says Swarup Mohanty, CEO of Mirae Asset Investment Managers (India) Private Limited.

The Trends So Far
The trend for passive investments is picking momentum, both domestically and globally. India is witnessing polarisation, especially in large-caps, making it difficult for active managers to beat the indices in short-term trends.

Another major reason dates back to when India witnessed a trigger in the re-classification of mutual funds.

80% of the allocation in large-cap funds was required to be in the NIFTY 100 stocks only. Therefore, the scope for deriving any kind of alpha was streamlined to 20% – making it a tough market to break bricks.

Shifting From Active to Passive
15 years ago, active investors were beating the market by 2-3 percentage points, according to Gaurav Rastogi, CEO of Kuvera. Now, high-calibre players, portfolio managers, PMS services, etc. are struggling for better returns in the market.

With too many fish in a pond, the competition tightens, leading to deteriorating performances. In the last 10 years, large-cap managers have found it supremely difficult to beat the market.

Despite some pockets of outperformance in the small and mid-cap returns on the active side, the market might flip in the next 5 years.

Understanding Investing Differences “A retail investor should not be a Robinhood investor”, says Prateek Pant, Co-Founder and Head of Products and Solutions at Sanctum Wealth Management. Your long-term goals are more important than the underlying. Choose passive strategies to make large-cap allocations as the core portfolio. For small and mid-cap sizes, there exists scope for creating alpha on the passive side. The market experiences imperfection in the form of asymmetrical information. The research is manager-to-manager driven; thus, chances for alpha generation are greater with such strategies. Passive indices are on the rise but not nimble enough. Don’t adopt a 100% allocation on either side. Involve a mix of both in the portfolio for benefits such as: 1. Low-cost solutions 2. Diversification within segments 3. Strategic allocation across funds 4. Complete diversification of assets

Differentiating Investor Suitability Gaurav Rastogi believes, “Stocks don’t move in isolation. There is always a story behind it and the story captivates you”.

Advisors will show the data and suggest suitable paths. But the final call rests with the investor.

As a novice investor, taking these calls will yield either money or experience. For example, investing for 1 year can make you heaps of money or grant you invaluable learning experiences.

Eventually, you will transition into a long-term investor and may earn both.

Different Routes for Indian Investors in International Markets The Liberalised Remittance Scheme (LRS) allows domestic investors to remit money overseas and participate in international funds via offshore platforms. Many of these platforms are offered domestically by brokerages via tie-ups.

In India, feeder funds haven’t received the attention they deserve. Plus, there are 39 routes available via Fund of Funds – one of the easier ways for a domestic investor to make informed decisions, according to Prateek Pant.

Some additional benefits are as follows: 1. Invest in Rupee 2. No requirement for filing additional returns (like in LRS) 3. Get global exposure

Challenges for Passive Investments in India
Passive investments/products are under a small portion of assets under advisory. The growth has been higher in passive investments/products, but a slow starting base and weak penetration pose challenges in the market.

As with other market inventions, passive investments/products may underperform for some time in the future. The growth rate will be higher in passives, but the quantum of money will dominate on the active side.

Are Passive Products the Next Big Thing? There is rising active-thinking and formation of passive products in the country. Globally, passives are shining in cloud computing and marijuana funds.

India also shows a promising threshold in this capacity. Many AMCs are entering into this thought-process. By next year, the answer would be floating across the market.

Disclaimer:
An Investor Education Initiative by Mirae Asset Mutual Fund.

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