There are two intriguing aspects to the latest M&A deal to be struck in the Indian mutual fund industry — Goldman Sachs Asset Management's decision to acquire Benchmark Mutual Fund.

One, why did Goldman Sachs choose a low-profile fund house like Benchmark to make its debut into the asset management space when much larger fund houses have been available for sale in India over the past two years? In a business where size decides profits, Benchmark's assets under management of about Rs 3,000 crore ($700 million) make it a relatively small player. To put this in perspective, Reliance Mutual Fund, the country's leading asset manager has over Rs 1,00,000 crore under its fold.

Two, why did Goldman Sachs choose to acquire a fund house that specialises in Exchange Traded Funds (ETFs) — funds that passively shadow the indices? After all, most mutual fund managers in India swear by active management, where the fees are higher and the aim is to generate index-beating returns by loading up on multitude of stocks that lie outside of the indices.

ETFs: A global hit

This buyout suggests that Goldman Sachs has chosen Benchmark deliberately because it wanted to take the passive route to chart its mutual funds' foray. After all, Goldman Sachs' India plans are not new; it registered its mutual fund operations with SEBI as far back as 2008.

Though ETFs have only a 0.5 per cent market share of the mutual fund assets in India, they are a big hit in the global context.

ETFs managed roughly $1.3 trillion in global assets in February with roughly half of the inflows into US equity funds every month coming in through the passive ETFs rather than actively managed funds. The popularity of ETFs has mainly to do with the fact that they minimise the risks and challenges associated with mutual fund investing and greatly simplify the process.

In the global market where the fund investor is already deluged by choices — between regions, countries and asset classes — an ETF investor does not have to drill down further and choose between products or fund houses to earn market returns.

Is India different?

Despite its popularity abroad, index investing has not really caught on with Indian mutual fund investors in a big way for two reasons. The returns of top performing equity funds in India tend to beat the indices by such a convincing margin (upto seven percentage points over a five-year period), that investors are tempted to take their chances.

Then, a fairly high proportion of funds manage to trounce the indices too. Over a five-year period, about 6 out of every 10 actively managed equity funds in India have beaten the Sensex returns.

However, even Indian fund managers are finding it harder to outperform the indices in recent years. The proportion of equity funds managing to beat the Sensex returns was as high as 75 per cent in 2007.

In the choppy market conditions since then, this proportion has steadily dwindled. Only half the active equity funds managed to outperform the Sensex in 2010.

This may be one reason why Goldman Sachs is placing its bets on passive investing, while it charts its Indian mutual fund foray.

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