Diversify Your Portfolio With Passive Investments

Anyone who is looking to build long term wealth needs to have their portfolio diversified to mitigate various types of risks. An investment portfolio can be diversified by holding different asset classes like equity, debt, gold etc. For many investors it may be difficult to select which schemes to invest in, at the same time, they want to invest in markets with relatively lesser risk. These investors can look at investing in Passive funds. Passive funds simply invest in widely tracked indices comprising companies forming part of that particular index. Apart from investing in broad market indices, it also allows investing in a sectoral index such as, Healthcare, Banking, Technology and so on.

Whether it is a new or a seasoned investor, investing in passive funds can be a good option for creating a diversified portfolio. It can be bought in addition to existing active funds in the portfolio for the benefit that passive funds offer such as market-linked returns, low tracking error, diversification, and transparency in the fund's composition. Investors can either choose to invest through SIP for a systematic investment approach or through lump sum, whenever the opportunity arises.

What is Passive Investing?

Passive investing is a method of investing that replicates the index in composition and returns. That means, there is no individual stock picking. There is a minimum intervention of a fund manager and the stocks that are on the index are bought in that same proportion. Investors can just choose the benchmark index which they want their fund to replicate and invest in it. Two of the most popular passive investing opportunities are Index Funds (Equity and Debt) and ETFs. These funds invest in stocks or underlying assets that constitute the index. They track and replicate the index. The difference between an index fund and an ETF is that ETFs can be traded throughout the day in the market hour like stocks, whereas index funds can be bought only for the price set at the end of the trading day.

Advantages of investing in passive funds:

Passive investing has some advantages that make it attractive and can form an important part of an investor's portfolio that can give relatively safer and stable returns.

Diversification - Diversification is the key to investments and passive investing offers an opportunity to invest in a diversified portfolio by replicating the stocks and returns of the underlying index. Passive funds invest in indices that cover various sectors and companies and hence automatically provide the benefit of diversification. For example, an investor can choose to invest in an Equity index fund like Nifty 100, Nifty Smallcap 50 or debt index fund like AAA Bond or the sectoral funds like banking, consumption, technology, healthcare etc. Having passive investments in a portfolio complements it by adjusting the risks from other investments.

Low tracking error - Tracking error is the difference in returns between the particular passive fund and its corresponding index. It is one of the important metrics when it comes to selecting passive funds so much so that instead of looking at the returns delivered, an investor should look at the tracking error of the fund. It gauges how much the returns have deviated from that of the benchmark index. The lower the tracking error, the better the index fund.

Transparent - Passive funds allow an investor to know what the fund is comprised of as it is the exact composition of the underlying asset of an index. This makes a fund easy and simple to understand, review and rebalance at any given point in time. An investor should have full information about the fund before making an investment decision which is easily available in the case of a passive fund.

Auto rebalancing - Rebalancing requires a lot of research and time to have an optimum mix of investments in the portfolio. However, in a passive fund, an investor is exposed only to the companies that are a part of that particular index. As a result, as and when the market cap of a company changes, it inevitably changes the composition of the index. Companies in the index keep reshuffling from time to time depending on their performance. The ones that are underperforming move out of the index and the fund is automatically rebalanced.

Risk Mitigation: Passive funds are ideal for those investors who want minimal exposure to risk and yet want to reap the benefits of equities in their portfolios. As the returns are adjusted to the index and the portfolio composition is automatically rebalanced, they are apt for risk-averse investors. When invested for a long period, it also helps help mitigate market risks and volatility.

Despite the many advantages, active investments will continue to be investors' first preference, however, investors are now broadening their horizons and investing in passive funds to get index-linked benefits and for the simplicity of the fund. Both active and passive funds can form a part of an investor's portfolio for the benefits that each category offers. Today, the market is at a point where there are multiple opportunities and innovative investment products for an investor to invest in. The passive investing universe offers the length and breadth for an investor's portfolio to grow. All an investor has to do is choose the right product to meet the risk profile, with the help of an expert and stay invested in the market.

The Author is Head Products & Alternatives, Axis AMC

Sources: Axis AMC Research

Disclaimer:

This report represents the views of Axis Asset Management Co. Ltd. and must not be taken as the basis for an investment decision. Neither Axis Mutual Fund, Axis Mutual Fund Trustee Limited nor Axis Asset Management Company Limited, its Directors or associates shall be liable for any damages including lost revenue or lost profits that may arise from the use of the information contained herein. Investors are requested to consult their financial, tax and other advisors before taking any investment decision(s). Statutory Details: Axis Mutual Fund has been established as a Trust under the Indian Trusts Act, 1882, sponsored by Axis Bank Ltd. (liability restricted to Rs. 1 Lakh). Trustee: Axis Mutual Fund Trustee Ltd. Investment Manager: Axis Asset Management Co. Ltd. (the AMC). Risk Factors: Axis Bank Limited is not liable or responsible for any loss or shortfall resulting from the operation of the scheme. No representation or warranty is made as to the accuracy, completeness or fairness of the information and opinions contained herein. The AMC reserves the right to make modifications and alterations to this statement as may be required from time to time.

The information set out above is included for general information purposes only and does not constitute legal or tax advice. In view of the individual nature of the tax consequences, each investor is advised to consult his or her own tax consultant with respect to specific tax implications arising out of their participation in the Scheme. Income Tax benefits to the mutual fund & to the unit holder is in accordance with the prevailing tax laws as certified by the mutual funds consultant. Any action taken by you on the basis of the information contained herein is your responsibility alone. Axis Mutual Fund will not be liable in any manner for the consequences of such action taken by you. The information contained herein is not intended as an offer or solicitation for the purchase and sales of any schemes of Axis Mutual Fund.

Past performance may or may not be sustained in the future.

Stock(s) / Issuer(s)/ Sectors mentioned above are for illustration purpose and should not be construed as recommendation.

Mutual Fund Investments are subject to market risks, read all scheme related documents carefully.

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