As we write, it is a full 5 years since the COVID pandemic struck and the post-pandemic recovery started. One of the big changes that did happen due to the pandemic was that it changed the way India invested. With low interest rates and ample liquidity, there was a surge of liquidity flowing to equities. Individual investors who stuck to their SIPs through the pandemic, ended laughing all the way to the bank. SIPs proliferated as the folios and the number of unique MF investors expanded. However, the big trend was the rapid growth in the folios of active equity funds, passive index funds and index ETFs. 

In the above table, we have covered the number of folios of each category of mutual funds. Closed ended funds have underperformed with negative CAGR over the last 5 years in terms of folios. That is not surprising considering the taxation changes and the loss of tax shields. Active debt funds and solution funds saw modest to flat growth. 

The real story was in the other 3 segments. Hybrid funds saw a lot of steam with allocation funds like multi asset allocation funds, balanced hybrids and equity savings funds attracting a lot of allocation interest from retail investors. Active equity funds saw logical growth with growth in folios across categories like mid-caps, small caps, flexi caps, and thematic funds. But the big story was the 67.4% CAGR growth in passive funds. 

It would be easy to dismiss the growth of passive funds as the outcome of a low base. While the base was low, there is a rhyme behind the growth. Here is what it is. 

1.  The risk of active debt funds, as highlighted in the Franklin Templeton case in 2020. The freeze on redemptions led to a strong preference for index-based debt products. Not just equity, even index debt products have shown robust growth.
2. Equity indexing is not hard to fathom. As active fund managers struggled to beat the index amidst challenges like volatility and kurtosis, investors found a safer and surer alternative in passive equity funds. That is what actually triggered growth.
3. Costs have been a major factor driving the growth of passive equity funds. Why pay 2.5% TER, when there is no assurance of fund managers beating the index. Passive funds surely look like a more elegant and economical alternative.
4. Finally, passive funds are simple to understand, transparent and the best way to diversify a portfolio and switch between equity and debt. That is the key. 

As John Bogle of Vanguard once said, “Why look for a Needle in a Haystack, when you can as well buy the haystack.” Indian investors have been smartly buying that haystack.