Make Money Passively!

Traditionally, the ‘do nothing’ approach has always been frowned upon. There definitely must have been a time in your past when your parents would have scolded you for just sitting at home and doing nothing. You, on the other hand, would have argued that you have already finished your studies and that it is time for you to relax. Investing is similar in nature. Just because prices move on a regular basis, it does not mean that your investment portfolio activity needs to move in tandem. Sometimes it is best to do your homework,  create an investment portfolioand then just sit back and do nothing. In the investment world this ‘do nothing’ approach is called passive investing.

The passive way

The role of passive funds is to track a market index or a basket of securities which is basically called the benchmark or the underlying fund. Their primary objective is to generate returns that are in line with the benchmark index. To achieve this goal, they simply purchase all the securities in the underlying index and in the same proportion as the index. In that sense, they simply replicate the underlying or benchmark index and then hold the positions unless there is rebalancing in the underlying. The objective of passive funds is to meet the returns of the market. Some key characteristics of passive funds include:

• The cost of managing passive funds is fairly low since the fund manager simply buys the securities in the underlying and then does nothing. As a result, there isn’t a great deal of activity and the costs are low.
• Since the fund replicates the underlying, it has no flexibility in terms of taking high conviction bets. Correspondingly, the returns generated can also not exceed the returns generated by the benchmark.
• The returns that these funds generate are slightly lower than the benchmark that they track. The slightly lower returns are due to expenses charged and tracking error.

The best part is that you can follow the passive way of investing while investing in both equity and debt instruments.

Equity passive funds

Equity passive funds create portfolios to replicate underlying equity indices. These could be the Nifty 50 index or any of the sectoral indices. By simply replicating the underlying equity passive funds solve the basic problems of both new and seasoned investors.

Passive funds for new to market investors

Investors who are just beginning their equity investment journey usually find it very challenging to choose the right equity investments for their portfolios. This becomes all the more difficult if you do not have an expert by your side. In such a situation, passive equity funds can be an ideal choice for you. They are simple, easy to choose and track, available at a low-cost, and offer market linked returns. Passive equity funds can also be a great option for all those investors who prefer to adopt a Do-it-Yourself (DIY) approach to investing.

Passive funds for seasoned investors

If you already have a portfolio of active funds then you can consider adding  passive funds to complement your portfolio and potentially enhance risk-adjusted returns. The addition of passive funds to the portfolio may reduce some risks of underperformance that may come through in an active fund in the short- term due to different investing styles.

Additionally, whether you are new to the market or a seasoned investor, you can also reap the diversification benefits of passive funds. When you invest in an equity passive fund, you get exposure to all the constituents of the benchmark through a single investment. If the benchmark is diversified, then your portfolio can automatically reap diversification benefits.

Debt passive funds

These are similar to equity passive funds in the way they are managed. In terms of composition, debt passive funds replicate an underlying debt index.

There are three main characteristics of passive debt funds:

• One, their primary goal is to create a portfolio of fixed-income securities that are issued by the central government, state governments, and even corporates and manage this portfolio passively.
• Two, the securities selected by the debt passive fund are the same as the benchmark index, both in terms of issuer and maturity.
• Three, since the securities are mostly held to maturity, the fund management expenses are very low and the returns generated from the fund are similar to the benchmark index, less tracking error.

Debt passive funds are suitable for every type of investor. They provide you exposure to high quality debt instruments in a low-cost and tax efficient manner.

Gone are the days when the passive or do nothing approach was considered lazy. Today, the passive investing approach can give you a strategic advantage and help you potentially enhance the risk-adjusted returns of your portfolio in a low-cost manner.

An investor education initiative by  Edelweiss Mutual Fund

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