Benchmarking of actively-managed funds to the Total Returns Index as well as the scheme categorisation norms brought in by the regulator were two game-changing measures in favour of passive funds, feels Vishal Jain, CEO, Zerodha Fund House. Vishal was part of the founding team of Benchmark AMC which launched India’s first ETF in 2001 - Nifty BeES, as Fund Manager. He has over 20 years of experience building ETFs and passive products. Excerpts from a web meeting:  


At Zerodha MF, you focus on passives and your first offering was a large & mid-cap fund. How did you choose to begin with this segment?

At Zerodha MF, we want to equip investors with products that are simple, transparent, and affordable because we believe that’s the only way that leads to greater financial inclusion. Passive funds exhibit these characteristics. As you mentioned, our first product was based on the Nifty Large & Mid cap 250 index. And it’s a kind of an equal split between large-cap and mid-cap. It’s a diversified index across about 20 sectors. It is a good combination where we felt large-caps bring the stability and mid-caps give the growth. We choose this index also because we wanted to launch one product where investors could keep investing in perpetuity and take exposure to the long-term India growth story, and this combination, as I said, was a good mix between stability and growth.


Is the one-way upwards market since the pandemic (barring some shallow corrections) driving interest passive funds? In a sideways, or bearish conditions, wouldn’t investors look for active fund managers who outperform the market? 

I think the bigger issue is, how do you pick a scheme? And secondly, how do you pick a winner ? Even if you look at the latest SPIVA (Standard & Poor’s Index vs Active funds ) report, it shows that over a 5-year period, around 58 per cent of the schemes have underperformed the benchmark in the mid &smallcap category, for instance . And over a one-year period, nearly 73 per cent have underperformed. There have been different funds beating their benchmarks or beating the index at different points of time. And therefore, I think the issue is, how do you choose a scheme? Thus, it makes more sense to have a good mix of passives in your portfolio.


On the debt side, target maturity funds as debt passives were very popular until the taxation change for debt funds. Do you think debt passives still make sense, and in which categories?

Investment should not always be looked at in terms of taxation. Target majority products fulfil a certain need as they have a fixed maturity, and you can use this product based on your specific time horizon or investment needs. It is akin to a fixed deposit, but, in my opinion, it has a much lower risk, because the portfolios are diversified and therefore don’t carry that single issuer or risk; whereas in fixed deposits, one is taking exposure to a single entity, especially in corporate deposits. Even in bank deposits, you have insurance cover only to a limited extent.

There are very few debt passive in the market apart from target maturity funds. Retail investors taking on to passive debt products has been a bit slow, but it is something that we would want to work on, and you’ll hopefully see a couple of products coming from our stable in the next couple of quarters or so.

Besides, if the liquidity and the depth of the markets increase due to inclusion of Indian government bonds in global emerging market indices, then it will be a very good thing for passive products. You will see more and more passive products, especially linked to government securities, coming into the market as we go ahead.


While ETFs are low-cost, there is a divergence among market price/NAV/benchmark of the funds, leaving investors confused on how to choose….

Things have become better over the years on the ETF liquidity front. I have been in the ETF market now for nearly 2 decades or so and I know the challenges we were facing, say, in the early 2000s. People are taking to ETFs. I remember correctly, in March 2020 there were only 18-19 lakh investors in ETFs. Today, it is 1.2 crore. Also, in the last two years, SEBI has introduced a number of positive regulations on the passive side where they’ve made it mandatory for fund houses to display the indicative NAVs on their websites as well as appoint market makers for every ETF. And therefore, if you see over the last 1–1.5 years, liquidity has kind of increased in many ETFs, especially the broad-based ones.


Apart from display of iNAVs and market making, what would you call as the game-changing measures that have given passive funds a lift? 

Two measures that SEBI took in 2017/18 helped. One was the benchmarking of funds vs the total returns index rather than the price index. The ‘dividend yield’ gap between the price index and the TRI was shown as outperformance by many active funds and that came to a end. Second, the scheme categorisation, saying that if you are a large-cap fund, you should invest in only the top 100 stocks by market capitalisation and so on and so forth. Otherwise, what was happening earlier was that you would call yourself a large-cap/bluechip fund but still have a good percentage of your portfolio in mid and small-cap companies and claim outperformance over a large-cap index. So, people started questioning the high expense ratios when there is no guarantee of performance and there was interest in index funds and ETFs.


Do you advise building a portfolio based on only passive funds?

I am a prime example of that. I have only 4 or 5 ETFs in my portfolio, and that’s what I’ve done for the last 15- 20 years. I don’t think my portfolio has done too badly. I generally pick a large-cap and a mid-cap passive fund. I always like to invest in gold, because it is an asset class where the correlation towards equity is very low.