Money flows in waves and each wave is determined by a certain narrative or story. In the middle of a wave, we as humans tend to amplify the story as the facts become self-enforcing. Over the last decade, there has been a significant move towards the allocation of passives in India. While this has come with the allocation in active funds coming down, there continues to be a question around the growth rate of active funds in the country.
Over the last 5 years (2017-22), the growth rate of active mutual funds in the country (equity AUM alone) has been underwhelming at a 6% CAGR (accounting for net new inflows) whereas the same for passive mutual funds (equity AUM) over the same period has been at 18% CAGR. The flow of money has always been historically associated with performance, and the performance of passive funds has outperformed active by 2% over the same period (measured by IRR) across categories. This has built to the narrative of money re-allocated from active to passive mutual funds in the country, over the long-term.
While it is simple to extrapolate narratives and get comfort through data, it does merit to pay attention to history around the flow of money and the trends we have seen in the oldest and deepest capital markets globally – the US.
Fig 1 : Change of Ownership of equities in the US over the last 70 years
Source : Federal Reserve, Goldman Sachs Research
Overview of trends in the US markets
There have been a few prominent trends that have built up in the US markets over time – first being the drop in Households as a % of public equities. It is interesting to note that as a country matures, the participation of households (retail direct participation) comes down while they resort to actively managed routes from a longer-term perspective. The drop in household participation has been accompanied by the rise of mutual funds, ETFs, Pension (401-k) and Hedge funds as a category.
The second interesting trend has been the growth of passives as a category. In the US, passives as a category began to gain prominence from the 2000 and today it occupies a 5% of the overall ownership today. While this has grown at the cost of actives, the contribution of active mutual funds continues to be at 14% (nearly 3x the size of passives and 2x the size of the ETF market)
The third important trend worth highlighting Is the growth of foreign investors over time. Today the allocation of foreign investors in the US is higher than the size of the active mutual fund industry in the US. This is a result of a multitude of aspects coming together – US being a home of capitalism, USD being a reserve currency, the depth of the US markets and the potential returns one generates vs the risk investors see.
What is worth highlighting in India
While the evolution of capital markets in India (in terms of size, scale and depth) may be 20 years behind that of the US (We are potentially where US was 20 years back), history suggests that we will see some of these trends rhyme in the country. While passives will continue to grow in our country, albeit, due to a lower base there continues to be a significant runway for active funds to grow in the country. More importantly, bottom-up stock picking opportunities will continue to drive alpha generation in the country (It is important to note that the worst decade in India for growth – 2010 to 2021 – saw 168 companies of the top 1000 companies give a 10x and above return over the same period).
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