The Securities and Exchange Board of India recently relaxed rules to enable mutual funds to launch passive investment schemes swiftly. You may wonder about the importance of this action. Despite all the noise about mutual funds through active campaigning, only three to four per cent of people invest through mutual funds.
The total assets under management of MFs may have topped R 60 lakh crore. However, as a percentage of gross domestic product or GDP, it is not even 20%. In developed markets, it is well over 100% of GDP.
When mutual fund regulations were put together in the 90s, the regulatory framework for eligibility, trustee and sponsor relationships, asset management, and other things
was designed with active fund management in mind. That means diversified equity, hybrid, and multi-cap schemes that involve a fund manager’s creation and maintenance of a portfolio. The job is to outperform the benchmark index. Hence, it is essential to have strict oversight when setting up a fund management team.
In the case of passive funds like index funds or exchange-traded funds, they follow a rule-based investment strategy set by the underlying index. The asset management company or the fund manager has little to do in this situation. For example, a Nifty 50 index fund will have the same allocation as the Nifty 50 index.
It will only change when the company managing the index changes the composition of the schemes. As a result, existing mutual fund regulations do not necessarily apply to passive funds. As a result, Sebi has introduced a Mutual Fund Lite framework for companies looking to launch only passive mutual fund schemes. New companies looking to launch only passive schemes can do so under these relaxed eligibility criteria rules.
What does it mean to you
If you are new to investing, index or exchange-traded funds are easy to understand. Your returns are in line with the benchmark index. For example, if there were an index fund that tracked the S&P BSE Sensex, the fund would have grown from 100 in 1980 to 3500 in 2001 to over 80,000 today. The compounded annual growth rate, or the average growth rate assuming reinvestment of profits, is around 13%. That is probably well above the average inflation rate in the economy over these years. The primary objective of investing must
be to beat inflation and create long-term wealth. Your retirement savings deserve the necessary time to grow into a corpus that can take care of your old age. The National Pension Scheme (NPS) allows you to opt for index funds for your retirement money. Till 15 years ago, India did not have such a meaningful, defined contribution scheme. India only had defined return schemes, such as an employee provident fund or a public provident fund, where the government paid a guaranteed rate of return.
However, due to the extent to which equity markets perform over 30 years, the government-guaranteed return schemes cannot match those returns. While equity-linked index funds do not guarantee any return, equity as an asset class outperforms all other asset classes over 30 years. The average annual return on NPS since its launch 15 years ago is 13%. No government guarantee scheme can offer you that kind of a return.
Your retirement plan should be a meaningful allocation to NPS and index funds if you are young or in your 30s. You do not have to understand the nuances of finance or dive into sectoral analysis too much. Knowing the big picture to understand the impact of global and local events on interest rates and corporate profits is good enough to get a sense.
You do not have to engage in timing the market and determine when to enter or exit. A steady inflow into index funds will allow you to create enough corpus to beat inflation and care for your needs.
Getting a professional financial advisor to determine suitable index fund schemes or exchange-traded funds would be a good idea. The new Sebi rules make it simpler for mutual funds to contact you.