S&P Dow Jones Indices — 31 Mar, 2021
The Shift to Passive in India
This article is reprinted from the Indexology blog of S&P Dow Jones Indices.
In 2020, the Indian ETF market continued to expand, finishing the year with ~USD 37 billion in assets spread across 99 listings. This represents a year-over-year increase of USD 23.3 billion, or 171%, placing India as the ETF market in the Asia-Pacific region with the highest growth on a percentage basis in 2020.1 Within the region, India represents the seventh-largest ETF ecosystem and the fourth-largest emerging market ETF ecosystem.
In a broader context, the Indian ETF market is over twice the size of the entire Latin American ETF market on an asset basis. It is larger than each individual country in the Middle East and Africa, including developed countries such as Israel. When looking to Europe, India would be the largest emerging market country and ahead of multiple developed markets such as Italy and the Netherlands, which have fairly robust ecosystems.
There are certainly several factors that appear to have driven this growth for the market, which reached its 20th anniversary this year. The most notable comes down to the relative outperformance of passive versus active funds. According to S&P DJI’s SPIVA® India Mid-Year 2020 Scorecard, the S&P BSE 100 outperformed 83.08% of active funds over the three-year period ending June 2020. So the most-tracked index on the Indian ETF market outperformed over 8 out of 10 active funds. This helps explain the underlying force driving flows into ETFs across global markets, which have seen passive overtake active in terms of percentage of total assets.
Herein lies a major headwind for the ETF industry in India. Active funds typically have fees that are higher than passively managed ETFs, which disincentivizes institutional ETF use. Equity fund fees average around 200 bps, while the fees associated with ETFs average around 5 bps.2 Investor education and Indian investor increased demand for ETFs may compel active fund managers to adjust their fee structure. We have already seen this shift in the U.S. and other markets, and there is no structural reason it could not occur within the Indian market as well.
Even with institutional headwinds, ETFs are making inroads in India. ETFs more than doubled their market share of the Indian mutual fund industry in 2020, moving from 4% of mutual fund assets in 2019 to 9% through year-end 2020.1,5 This growth comes on the heels of regulatory change that could affect the way investors view ETFs. In 2018, the Securities and Exchange Board of India (SEBI) changed benchmarking rules for active equity funds to more accurately depict active fund performance,3 and in 2013, it imposed standards for fee-based advisors that would require them to exercise a greater duty of care for investors when compared to institutional distributors.4 Both these changes have set the stage for the possibility of continued long-term growth into low-cost passive funds in the Indian market.
1 ETFGI, December 2020
4 https://www.sebi.gov.in/sebi_data/attachdocs/1358779330956.pdf
5 https://www.outlookindia.com/outlookmoney/mutual-funds/mutual-fund-aum-rises-17-in-2020-5824
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