Midcap, Smallcap Index Funds from ABSL & Nippon India?

Why this kolaveri to launch index funds by AMCs? Is it worth the cost and effort, given the poor interest among investors and "advisors"?

Published on / By M. Pattabiraman Twitter: @pattufreefincal

Published: February 27, 2020 at 11:10 am

Last Updated on February 27, 2020 at 11:10 am

In Feb 2020, Aditya Birla Sun Life AMC has filed three draft scheme information documents (SID) with SEBI: for a midcap index fund, smallcap index fund and Nifty 50 equal-weight index fund. In Jan 2020, Nippon India made three such filings: midcap index fund, small cap index fund and Nifty IT ETF.  Why are AMCs chasing after passive AUM when they have active funds in the same category? Is it worth the effort?

These draft SID filings do not always pan out as an NFO launch. Motilal Oswal filed for a Nifty LaregeMidcap 250 Index (which would have been quite interesting) but choose to convert that into an active fund and launched four index fund at the same time – Direct Investors Prefer Motilal Oswal Small Cap Index Fund from their four Index NFOs

Links to draft SID filings with SEBI

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Naturally, AMCs have only one aim in mind – AUM. The only reason they launch NFO after NFO is to get that nice spike in profits that a new fund offers. The ideal NFO is one that results in at least 1000 Crores of AUM during the NFO period and this is possible only if there are significant commissions involved.

As reported before – Are Indian Investors ready to choose Index mutual funds or ETFs? – even for index funds, AMCs require distributors (at least in the NFO period) to generate AUM momentum.

Even with distributor help, AMCs can only expect tens of Crores from each index fund NFO (much less, if it is an ETF as there are no regular plans here!). So why do it? Sustainable AUM growth in index funds is possible only via direct plans and only if the expense ratio is enticing low. Ultimately it will become the battle of expenses.

Even after seven years of direct plans. AMCs have failed to create a “direct following” among investors with exceptions like Quantum and PPFAS. They cannot rely on distributors to bring in passive AUM beyond the launch.  This can grow only if AMCs advertise it, the direct portals recommend it, but even here past performance, star ratings and peer comparison influence investors.

As of now, the popularity of an index fund boils down to sheer luck – favourable market conditions. So why are so many AMCs filing for passive funds? “We would like to offer investors a choice” will not wash. A supermarket offers choice. A fund house should offer a clear investment objective.

Naturally, they are trying to exhaust every possibility in the SEBI categorization rules. Why do you think you see so many thematic (ESG!) funds? This is because of a clause in the rules

Only one scheme per category would be permitted, except,  i.Index Funds/ ETFs replicating/ tracking different indices; ii.Fund of Funds having different underlying schemes; and iii.Sectoral/ thematic funds investing in different sectors/ themes

ABSL has filed for an ESG fund! So has DSP! Can one not think of any other investment theme? Hard to react any other way than “copycats”!

So the goal would now be to launch as many index funds, as many thematic funds and as many fund-of-funds as possible as there are no limits on the number of funds in these categories.  The lack of uniqueness in the scheme mandates compels us to ask,  Is this a case of AMC FOMO (fear of missing out)?

It would take investors of incredible maturity to continue investing in passive funds especially in the midcap and smallcap segments where past performance is just about everything!

Perhaps hybrid index funds or factors-based index funds like NIfty 100 Low Vol 30 could be a better selling point, but in terms of AUM, it would almost be foolish to bet that they would do any better.

This spate of passive funds can only be seen as AMC competing for a piece of what is already a thin slice of AUM. Is it worth the trouble? Will it be able to justify the huge promotional costs of launching each fund (paid tweets, articles etc)? The big challenge for AMCs would be conviction. They cannot justify a passive fund in their portfolio when they have active funds in the same category.

DSP tried to do this during their DSP Nifty 50 Index Fund & DSP Nifty Next 50 Index Fund launch in Feb 2019. In its NFO campaign DSP has admitted that index funds are relevant today for two reasons:

Introduction of SEBI re categorization which has confined the universe for active large cap fund managers & Introduction of TRI indices

The promotional pamphlet also points out to the over 4% reduction in average alpha from 2000-2009 to 2010-2018 when three-year and five year rolling return periods are considered. This is shooting themselves in the foot!

AMCs will have to recognise the need to “directly” interact with investors. Showcase their overall investment mandate and how each product serves that mandate. This is the only way to sell at least passive mutual funds when information spreads so easily! It would also help if each product is unique in its basket of funds.

Without this, long-term profits in the passive universe would be hard to come by and the launch AUM would literally be a flash in the pan. I cannot but wonder if Benchmark Mutual Fund that exclusively dealt in ETFs would have done better if launched now. Goldman Sachs acquired it in 2011 (and added one index fund – NIfty 500), sold to Reliance (2015) who in turn sold to Nippon India (2019).