We live in a time that allows us a multitude of options, whether they are technological, cultural, or social. It can be challenging to make the best choice, whether looking for a mobile device, a restaurant meal, or a good investment.
This is crucially true in the financial context too. Both institutional and retail investors are searching through a myriad of options to protect, add value and grow their assets. While investment institutions have access to unlimited research and high-quality advice, individual investors do not have it so easy. Although there are investment advisers and there is access to public information, the challenge is financial literacy and awareness.
Professionals in varied fields are often too busy to research, plan and understand the best investment style. A common worry is the risk associated with equity, primarily due to inadequate knowledge and the associated myths.
There would be less number of reasons to worry if these inventors knew about ‘passive investing’. Also known as index-based investing, it requires an understanding of what an index is.
An index is a basket of financial instruments, be it equity (stocks), debt (bonds), or commodities, designed by an independent index provider, which does not trade or create investment products, but merely publishes the index value.
The design of an index can be based on an asset class, geography, strategy, theme or any other concept. The index offers the advantages of diversification, hence avoiding concentration risk of single stock or instrument exposure.
It further offers transparency and non-bias through its publicly available rules based methodology. Passive or index investing is investing in the index basket in the same proportion as is provided in the index. Index trends can, for example, guide investment strategies to make choices based on how the index reacts to different market cycles.
Trends of several indices over the last few years are shown above. Investments in products based on such indices are likely to follow similar trends.
Passive investing gives exposure to a diversified basket of investment instruments at a low cost. The underlying index is designed by a highly professional, well established, and independent index provider, such as S&P Dow Jones Indices. It will allow a person with insufficient financial knowledge to follow the market and its trends easily by just tracking the index.
Passive investment by individual Indian investors was negligible a few years back, but now constitutes over $12 billion. Globally, markets have realised the potential of this strategy, with over $5 trillion assets invested passively.
Passive investment index funds and exchange-traded funds follow various strategies to track different indices. The indices can track markets like the S&P BSE Sensex, which tracks Indian markets, the S&P500 tracking the US markets. Other indices track sectors, such as S&P BSE Bankex, S&P BSE Energy and S&P BSE Finance.
Factor Indices are now making headway into global markets as well as India, with quality, momentum, value, and low volatility as single factors or multi-factor variants. Different indices have different characteristics and different risk-return features.
Suitable options are available based on required objectives and goals. The distinctive growth of assets through ‘passive’ products is a compelling impetus to consider passive investing as the first preference in an investment strategy.