Asset allocation is a strategy that is considered a touchstone of a successful investment journey. Asset allocation entails apportioning your capital in a wide variety of asset classes. The underlying idea is that by diversifying across different investment instruments, the risk factor does not get concentrated in your portfolio and should one of the asset classes exhibit worrisome performance trends, the effect can be absorbed by other asset classes. This is because no two types of assets display similar movements in response to market to economic triggers and this way you can strike an optimum balance between risk and rewards in your portfolio.

The narrative around mutual fund investments and how they are managed can look too complicated for newbie investors. This is where passive investing and passive funds can fill in the gaps for investors who are finding it difficult to navigate the water of actively managed funds. Asset allocation objectives and maintaining the right levels of diversification in one’s portfolio can become a simplified endeavour with passive funds and that too much lesser costs that what investors incur on active fund management.

The buzzword around passive funds has been getting stronger and more and more investors are jumping on to the bandwagon - a report by BCG on the global asset mix of mutual funds showed that the AUM of passive funds was pegged at $22 trillion in 2020, which is expected to rise to $34 trillion in 2025. The data from the Association of Mutual Funds in India shows that net assets under management of passive schemes stood at Rs 4.72 trillion as on December 2021, compared to Rs 2.94 trillion in December 2020 - an increase of 60.5 per cent.

The rally is here to stay. Several factors are catalyzing this such as market-linked returns, negligible tracking error, diversification, and transparency in portfolio composition. Investors are also eyeing passive funds with renewed enthusiasm because passive funds can serve varying needs – investors can ensure downside protection to their portfolios without losing out on the potential offered by domestic markets.

Now let’s look at the benefits of asset allocation

• Asset allocation ensures that your portfolio does not become weighed down by one asset class. The right asset allocation strategy ensures that investors maintain a delicate balance between utilizing windows of opportunities to maximize returns and mollifying the overall risk element should there be a shock wave in one asset class.
• A sound asset allocation formula can facilitate better returns through your investments than a scenario where your investments are concentrated in one or very few asset classes. Different asset classes are impacted by market conditions in different ways and the dissimilarities in the reactions will help you maximize your returns in the long run.
• Adherence to appropriate asset allocation strategies can ensure that you continue to invest in a disciplined way in all market conditions instead of reacting to different market scenarios. You can rebalance your portfolio from time to time to ensure that the risk factor does not spike beyond your tolerance levels.

When it comes to effective asset allocation, your portfolio can consist of both active funds and passive funds. Active funds can be used to potentially grow your funds while passive funds can be used to generate equity like returns but with lower risk.

There are many investors who want to start with a diversified portfolio, they would buy the market and then move to active where the risk might be more. Some of them might not even want to go active. Another part is that active funds have restrictions of one scheme per category. Hence, there is an edge in passive space.

Passive investing through ETFs

ETFs are a basket of funds that aim to mirror an underlying index such as the Sensex of Nifty and are one of the most popular options of passive investing. There are ETF offerings on a wide variety of asset classes ranging from traditional investment instruments to commodities or currencies. ETFs, unlike actively managed funds, do not strive to surpass the benchmark index. ETFs are listed on all major stock exchanges and investors can trade ETFs like shares of listed companies. You need to have a demat and trading account with a stock broker to invest in ETFs and you can buy or sell ETFs in the stock exchange during market hours at prevailing market prices.

In the case of actively managed funds, there can be a chance of some sectors, stocks having a higher weightage relative to the benchmark. This can compound risk owing to sector or stock specific elements. In the case of ETFs, the basket stays representative of a particular index and the stocks are in the same weightage as the index itself. Thus, unsystematic risks get ironed out in ETFs.

Conclusion

The mutual fund industry is going through a sea change and the passive wave is one of those that is driving investors to re-evaluate and reassess their doubts about mutual fund investments. With more and more fund houses spearheading the movement by offering innovative schemes that track various indices and sectors, the passive fund phenomenon will clearly have something for everyone.

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Mutual Fund investments are subject to market risks, read all scheme related documents carefully.