Opting for a passive portfolio

Nov 19, 2020
A reader wrote in with this query. And we attempted to give him a broad perspective.

I have Rs 30 lakh. I want to invest it for 10 years. I only want ETFs and Index Funds. Suggest me the mix.

You want to invest for a decade which is a long-term frame, excellent for equity. But you are clear that you are only interested in passive products.

We are clueless about your overall portfolio or your approach to equity. Hence, we encourage you to ask yourself these questions.

Why not actively managed funds?

Actively managed funds are those wherein the fund manager invests in select few securities from his investment universe, which he expects to outperform the benchmark. Exchange traded funds (ETFs) are passively managed funds, in that they track/replicate an index by investing in the same securities as that in the index and in the same proportion. Compared to actively managed funds, index funds/ETFs offer significantly lower expense ratios.

Investors opt for exchange traded funds only if they believe that active managers cannot outperform the benchmark after expenses over their investment horizon. In recent times, most fund managers particularly in the large-cap segment have found it difficult to beat the benchmark. Hence the increased attention towards passive funds and ETFs in recent times.

Are you aware of the working of passive products?

One should be mindful of the risks of investing in passive funds/ETFs such as security concentration risks, and additionally exchange-related liquidity risks in case of ETFs. If the underlying index has no cap on security level weights, the index fund/ETF may turn out to have high concentration to select top-performing securities, which exposes an investor to company specific risks. Exchange-related liquidity risk too is a key risk, since despite the low costs of the ETF, an adverse bid-ask spread may work against investor interest having a significant impact at exit.

Have you considered asset allocation?

You mentioned ETFs and index funds, so am assuming you want an all equity portfolio.

An asset allocation-based (mix of equity and debt) approach should be followed for portfolio construction, as it is one of the key determinants of the portfolio’s performance. Higher the investment horizon and risk appetite, higher can be the allocation to riskier asset classes such as equity which have the potential to deliver relatively higher returns compared to fixed income over the long term.

Assuming an aggressive risk profile given the time horizon of 10 years, you can invest with a portfolio mix of about 80% into equities and 20% into fixed-income funds. The equity allocation can be split up as 50% into large caps, 10% into mid caps, 5% into small caps, and 15% into international equities.

The international equity allocation offers diversification across geographies with exposure to different growth drivers, and a hedge against currency risk. Currently in India, only domestic equities have index funds/ETFs representing different market segments (large/mid/small caps) as well as the broader market. Passive international equity exposure is offered by a handful of funds, which are entirely U.S. focused.

There are a few India domiciled passive funds/ETFs offering fixed-income exposure in India, such as Liquid ETFs, 10-year gilt ETFs, and the Bharat Bond ETF/FoFs which invest primarily into AAA-rated PSU entities and G-secs and have a run-down maturity restricting investors from selecting a target duration.

For investment in fixed income, you can consider open-ended accrual fixed income funds with a high credit quality portfolio such as Banking & PSU debt funds, Corporate Bond funds, and Medium-term funds. As your goal approaches (2-3 years before the goal), shift allocation out of equity into fixed-income funds to lower the risk of drawdowns.

What is the return you are looking at?

Investing your corpus of Rs 30 lakh as per recommended asset allocation, you may be able to attain about Rs 68 lakh at the end of 10 years. The corpus amount has been computed assuming equity market returns of 9.5% per annum and fixed income returns of 5.5% per annum.

It is advisable to stagger your investment corpus across say 3 to 6 months, to benefit from rupee-cost averaging, which seeks to average out the investment cost particularly during times of market volatility.

Do note, these are just broad guidelines. Please consult your financial advisor before making any investment decisions. To evaluate mutual funds across categories, one can look at Morningstar’s star ratings and analyst ratings.

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ninan joseph
Nov 21 2020 05:47 PM
There was word limitation hence this is second part

Do not invest in Index Funds - ETF is far superior product than Index ETF. They continue to take higher commission.

Another important note, when you invest in ETF do not go for anything other than the index. There are many other funds such as Gold ETF, Alpha ETF, etc. Do not get swayed by what these advertisement say. They are not good. ETF is only great when it replicates what we all know the nifty etf. Go to you tube and read on ETFs. Vanguard started this few centuries ago and one of the best product in USA.

Why I am ok with nifty next 50 is because it is investing in companies which are next in line to be in nifty. This basically covers 100 companies of India and this is as good as it gets.

I am an investor in these two ETF. I started off with Kotak nifty 50 and then realised that their AUM is small and their commission is higher than SBI.

SBI ETF is humongous and you can be rest assured that these guys would not do any

the other suggestion, I have is since you have corpus go for NPS. One of the best product in the market but nobody talks about it as commission to distributor is very low. When the market crashed, my portfolio was still showing .5% low. I am an investor in NPS since the very begining. This is something similar to what in USA have called retirement 401K account. This is long term and you cannot touch it.

So if i were you, I will do the following.

Open an account with IDFC - They give interest rate of 7% on SB account.
I am sure you have a brokerage account and a demat account.

Start your first investment of 100 units in Nifty 50, then Nifty next 50. Wait see how the market reacts, when there is a dip go for the second lot and build up your base. It is upto you as to how much should be your initial lot. I will restrict it to 100 units or 200 units. Remember there is brokerage involved. So check on broker which gives you the cheapest.
God luck to you.
ninan joseph
Nov 21 2020 05:37 PM
Dear Question Asker.
The answer to your question is
Invest in SBI ETF Nifty 50 - This covers india top 50 company. Why SBI, this is because this is the biggest ETF with AUM over 73,000 crore. All of India incremental EPF funds are routed though this fund. Also the commission they charge is low - 0.07.
Few important points that you should consider is the pedigree of the AMC - SBI stands out and the AUM under management. The AUM determines the commission and I am sure SBI will reduce the existing 0.07% to lower.

Second - You can think of another ETF from SBi called - ETF Nifty next 50 - This ETF invests in the next 50 companies after nifty 50. If you invest in these two ETFs, then basically you are covering 100 top corporates of india. The advantage of Nifty next 50 is that there are different variety of corporates here, such as Insurance, AMC, Pharma and mid size banks. If you are invested in Nifty and Nifty next 50 then you are covering the entire gamut of banking stocks or indirectly have exposure in Bank nifty. The aum is lower and commission is a tad higher but the pedigree of AMC is unquestioned. Go for this.

Do asset allocation on these two ETFs - put 60 in ETF Nifty and 40 in Nifty next 50. Do not put all the money in one shot. As there is brokerage involved invest in 10,000 lots. What I mean is do not divide 10,000. First buy ETF Nifty and then next tranche buy nifty next 50.

ETF is the way to go forward. This is the cheapest product which has exposure to markets without portfolio manager etc. They basically do nothing. Think of FT, think of so many mutual funds, they take commission on AUM and not on the gains made. The world has already changed to ETF, India is lagging behind but is soon catching up.

Do not get swayed by what the author is trying to say about active fund etc. Everyone will say these things when the market is a rocket high level. None of these guys were around in march when market crashed.
Good luck in ETF
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