India’s potential in Passive Investing

20/2/2020

PUNE: Globally, passive investing—which aims to replicate index returns--has been embraced for being a low-cost, transparent, and objective investing tool for investors. And for good reason—the SPIVA (S&P Indices Versus Active funds) Scorecard shows that it is becoming increasingly difficult to outperform the market on a consistent basis globally, including in India.

The latest SPIVA India Scorecard has also showed that 77% of large-cap equity funds underperformed their respective benchmark indices during the previous calendar year. It is essential to understand that the equity market is a zero sum game; one can earn alpha if another investor earns negative alpha. Additionally, trying to earn alpha through active means can sometimes cost more than the comparable passive investment. In India, recent regulatory changes by SEBI, such as mutual fund categorization and performance comparison using total return indices, are expected to create the job of the active fund manager even tougher.

Assets under management (AUM) for India’s exchange traded funds (ETFs) have seen exponential growth over the last five years. From December 2014 to December 2019, total AUM grew from a mere US$ 2 bn to US$ 14 bn.

The key driver of the substantial growth in equity ETF AUM has been government initiatives, one of which is the disinvestment by Government of India via ETFs. Also, in 2015, EPFO’s (Employee Provident Fund Organization) decision to start investing in ETFs that track leading indices, such as S&P BSE SENSEX, was another key driver of the substantial growth in ETF assets. Through a recent amendment made by the Central Board of Trustees, EPFO is now allowed to invest 50% of its funds in the S&P BSE SENSEX.

Recently in January 2019, SEBI also introduced portfolio concentration norms for equity traded funds and index funds aimed at addressing the risk related to portfolio concentration in such products.

New themes such as factor investing and ESG (Environment, Social and Governance) are also gaining greater traction globally as well as in India. 

A factor can be thought of as an element that helps to explain the source of risk/return characteristics of a portfolio. The broadly recognized factors are size, dividend, volatility, momentum, quality, and value. S&P BSE Enhanced Value, S&P BSE Dividend Yield, S&P BSE Low Volatility, S&P BSE Momentum, S&P BSE Quality are indices that are designed to measure the performance of their corresponding factors. Similarly as risk of climate change, social unrest, and poor governance increases, environment, social, and governance aspects are being methodologically analyzed and factored into the investment analysis. 

The S&P BSE 100 ESG index is a good example of an ESG index that measures performance of companies that score relatively higher on these types of parameters. Still newer investment themes are starting to take shape. For instance, rapid developments in robotics, automation, and artificial intelligence, together with extreme connectedness and the availability of exponential processing power, have laid the foundation for seismic changes across all facets of our lives. As we enter what is being referred to as the Fourth Industrial Revolution, the S&P Kensho New Economy Indices: 21st Century Sectors℠ dynamically capture the companies that are propelling the revolution.

 

The Kensho New Economy indices are constructed using an entirely systematic, rules-based methodology. Leveraging Kensho’s proprietary natural language processing (NLP) platform, millions of pages of regulatory filings and other public information are analyzed to identify the companies involved in each of the New Economies. Some of these indices include the S&P Kensho New Economies Composite℠ Index, S&P Kensho Clean Power Index, S&P Kensho Space Index, Drone Index, and the S&P Kensho Electric Vehicles index.