Passive Investing: Why Doing Less Can Sometimes Earn You More

In recent years, passive investing has steadily moved from being a niche concept to a mainstream strategy in global markets. What started with Vanguard in the United States over 25 years ago has today become one of the most dominant trends in asset management. The basic premise is that instead of attempting to outperform the market, investors can simply imitate it – via instruments such as index funds or exchange-traded funds (ETFs) – and possibly end up with superior long-term results.

So what are passive funds?

Essentially, passive investing involves no interference from a fund manager, in terms of stock picking. The fund merely mirrors a selected index. For instance, if you have invested in a Nifty 50 Index Fund, it will possess the same 50 stocks in the same proportion as the Nifty 50 index. In the same way, today we have passive funds following Sensex, Bank Nifty, and even theme or small-cap indices.

The reasoning is simple. If the investor thinks that the index itself is a diversified and stable basket of stocks, then owning the index suffices. Rather than investing in high fees for an active manager who attempts to select stocks, the investor can obtain widespread market exposure at a much lower fee.

The world over, the concept has caught on in a huge manner. In the US, passive funds have already surpassed active funds in terms of under management[1]. In India as well, the segment is expanding very fast, with the boost from ETFs and government-sponsored pension funds like EPFO[2] and NPS investing humongous amounts in passive strategies.

Active vs. passive: The big debate

So why on earth do investors even have to consider active vs. passive? The reason has to do with the character of markets.

Active funds are fueled by a fund manager’s expertise in researching, analysing, and picking individual stocks. If the manager can spot winners before the market, active funds can produce alpha – or returns above the benchmark. But as with any risk, not every fund manager will be successful, and not all active funds will beat the game consistently.

Passive funds, by contrast, take away that uncertainty. They do not promise outperformance, but they guarantee that your returns will be in line with the market, minus a very small expense ratio. For many investors, especially those who prefer predictability and lower costs, this is an attractive proposition.

Globally investors have increasingly recognised that consistently beating the index is very difficult. Therefore, many have shifted a significant portion of their portfolios into passive products.

Why passive investing is catching on

There are a few clear reasons why passive investing is gaining traction in India as well:

1. Cost Efficiency – Passive funds usually have expense ratios as low as 0.1% to 0.2%, compared to 1% to 2% for active funds. Over the long term, this cost difference compounds into a significant gap in returns.
2. Transparency – Since passive funds replicate a published index, investors always know exactly what they own. There is no hidden decision-making or sudden churn of portfolios.
3. Diversification – By owning an index, investors automatically hold a broad basket of companies across sectors. For example, the Nifty 50 covers banks, IT, consumer, pharma, and more.
4. Performance reliability – While some active funds may outperform in certain years, many also underperform. Passive funds remove the risk of underperformance relative to the benchmark.

These advantages are pushing more institutional as well as retail investors towards passive strategies.

The Indian context

In India, the active fund management industry has historically done well, partly because the markets were less efficient and there were more opportunities to spot mispriced stocks. However, as markets mature, information becomes widely available, and competition increases, it becomes harder for active managers to consistently generate alpha.

This is where passive investing can play a larger role. Products like Nifty 50 Index Funds, Sensex ETFs, or even more targeted passive strategies such as sectoral indices and small-cap indices are already finding takers.

The Way Forward

The future is unlikely to be an “either-or” scenario. Instead, most investors will end up adopting a core-satellite approach. The core of the portfolio could be built using low-cost passive funds that provide stable market exposure. Around this core, investors may have satellite positions in active funds where they believe a manager has the skill to generate alpha in specific segments, such as mid-caps or thematic strategies.

The key is balance. Passive investing offers simplicity, cost efficiency, and predictability. Active investing offers the chance of superior returns if done well. A mix of both can help investors create resilient portfolios aligned with their risk appetite and financial goals.

For those seeking a disciplined, predictable, and cost-efficient approach, passive investing may well be the answer. As the saying goes, sometimes the smartest strategy is not to beat the market but to simply be the market.

[1] https://cafemutual.com/news/passives/34893-how-are-passive-funds-faring-globally

[2] https://www.deccanherald.com/business/personal-finance/what-s-fuelling-the-surge-in-passive-investment-3663504