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31 January 2025

Investor Preferences Shift Amidst Mutual Fund Boom

Despite the rise of passive funds, active strategies maintain dominance with 84% market share as of December 2024.

India's mutual fund industry is witnessing significant growth, with assets under management (AUM) surpassing Rs 66.93 lakh crore as of December 2024, according to Motilal Oswal Asset Management Company’s latest report. The study, titled ‘Where the Money Flows,’ highlights the rise of passive funds, now holding Rs 10.85 lakh crore, representing 16% of the total market share. Despite this rise, active funds maintain dominance with AUM of Rs 56.08 lakh crore.

What drives investors to choose between active and passive funds? Active funds are typically managed by professionals who aim to outperform benchmark indices through strategic buying and selling, but they come with higher fees. On the other hand, passive funds, which aim to replicate the performance of specific market indices, are known for their lower expense ratios.

According to Prateek Agrawal, managing director and CEO of Motilal Oswal Asset Management Company, “India’s mutual fund industry has seen remarkable growth, driven by economic progress and rising financial literacy. This expansion reflects the industry's ability to meet diverse investor needs and strengthen the financial ecosystem.”

The preference for equity funds appears strong, with the study indicating they command 60.19% of the total AUM. Notably, the last quarter witnessed substantial inflows, as active equity funds led with Rs 105,000 crore net inflows against Rs 29,000 crore for passive equity funds.

Hybrid funds and debt funds also play significant roles, accounting for 8.58% and 26.77% of the total AUM, respectively. The preference for broad-based funds is evident, with 69% of net inflows directed to them. Interestingly, active broad-based funds saw their share increase from 57% to 70% quarter-on-quarter.

Flexi Cap and Mid Cap funds, too, received considerable interest, with both categories attracting Rs 15,000 crore each. This trend indicates a shift as more funds are redirected from large-cap allocations to mid-cap and small-cap segments.

On the thematic front, mutual funds observed mixed results. Net inflows for thematic funds decreased from Rs 17,000 crore to Rs 14,000 crore, though consumption and infrastructure themes attracted significant attention with Rs 4,500 crore.

Performing well, debt funds saw constant maturity funds dominate with Rs 37,000 crore net inflows, emphasizing continued investor confidence. Liquid funds are also highly sought after, holding 41% of the net inflows due to their short-term investment appeal.

While the figures indicate general market enthusiasm, the exploration of passive funds via unit-linked insurance plans (ULIPs) unveils differing narratives. Despite their portrayals as low-cost options, index ULIPs often carry hidden fees akin to active funds. Many insurers charge similar fund management costs (FMC) as those for actively managed funds, which can exceed 1%, significantly diminishing returns for policyholders.

Deepesh Raghaw, an investment advisor, states, “The tracking error tends to be higher in funds with small-cap stocks due to difficulties in bulk trading.” This elevated tracking error poses challenges for both the policyholder and the insurer, making the case for mutual fund options more appealing for those seeking straightforward market returns.

Investment flexibility is another concern. ULIPs limit investors to one fund basket, whereas mutual funds allow for switching between various asset management companies. This flexibility can prove pivotal for adapting to changing market dynamics.

Despite their inherent appeal, ULIPs should be approached with caution. They should primarily cater to individuals requiring life insurance coupled with investment options rather than serving as vehicles solely for capital growth. Raghaw advises seeking standalone term plans for life cover at lower costs.

Overall, the mutual fund industry continues to evolve, shaped by varying investor preferences between active and passive strategies.

With the increase of investor awareness and financial literacy driving asset growth, the balance seems to tilt slightly more toward active strategies, even as passive options gain traction. The dynamics between these two investment approaches will likely influence the industry's future, directing both investor capital and market trends.

Market trends suggest active funds will continue their dominance, but growing investor interest in passive funds indicates they will play an increasingly significant role. Consequently, the future of India’s mutual fund industry will be closely tied to how these two strategies perform against each other and how investors navigate the rapidly changing scene.

This year’s report shines light on key shifts within India’s investment ecosystem, inspiring informed decisions as investors examine their options. The coming months and years will be pivotal as the dynamics evolve, particularly as fund managers, financial advisors, and policymakers respond to the shifting preferences of millions of Indian investors.