Asset management companies (AMCs) may double down and innovate more on passive products following the revision of mutual fund categorization norms, offering investors a wider choice of investment options.
Passive funds typically track indexes and don’t require active management. While passive funds have been growing steadily in India, the new cap on portfolio overlap may catalyze greater innovation in such products and their growth.
“The restrictions on portfolio overlap can be a trigger for passive investments. Mutual funds may look at creating differentiated products in passives and improve innovation in the space,” said Archit Doshi, senior vice president at Prabhudas Lilladher Capital Group.
As fund houses start offering more passive funds, investors may benefit by getting access to a wider variety of lower-cost options.
The Securities and Exchange Board of India (Sebi) mandated fund houses on 26 February to ensure that schemes offered by them within a category are meaningfully differentiated. The market regulator capped the portfolio overlap between thematic and sectoral funds and other equity schemes at 50%, excluding large-cap funds.
Thematic and sectoral funds together managed ₹5.24 trillion as of January, according to data from the Association of Mutual Funds of India (Amfi). Over the past year, there were 37 new fund offers in these categories, compared with 19 across the broader equity segment.
While Sebi permits only one scheme per category in most equity segments, there is currently no limit on the number of sectoral and thematic funds that an AMC can launch. This had led to a surge in offerings built around similar stocks packaged under different narratives.
Three categories
With the 50% cap in place, maintaining multiple differentiated active strategies within a constrained universe may prove difficult. Passive funds, by contrast, offer a clearer template. They can be launched in three categories—index funds, exchange-traded funds (ETFs) and Fund of Funds (FoFs).
Index funds construct a portfolio that replicates a market index by holding the same securities in the same weights, without the fund manager actively rebalancing them based on market or sector views. ETFs can be launched in equity, debt and commodity variants. FoFs invest in a portfolio of other funds rather than directly in stocks, bonds or other securities.
“Ideation is more open in passives. Categorization has restricted fund launches. But mutual funds can innovate in passives. Real innovation happens in passives across the globe,” said Swarup Mohanty, vice chairman and chief executive officer at Mirae Asset Investment Managers.
The next phase of growth may be in factor-based passive funds, a sub-category of passive schemes that extend beyond plain-vanilla index trackers.
Factor-based passive products track indices constructed on parameters such as higher returns on equity, stronger dividend yields, lower volatility or quality metrics. They could see greater traction as AMCs look to offer differentiated yet rules-based exposures.
“Mutual funds can look at creating factor-based passive products which are based on rules such as including stocks of better ROE or those with better dividend yield,” Doshi said.
Innovation could also appear in more sector-specific, structured products within ETFs and index funds.
"These may be focused on 10, 20 stocks or a specific sector such as EVs (electric vehicles) or any other future product pushing the risk-reward matrix," said Mohanty.
To be sure, innovation in passives may not change dramatically overnight.
“The shift to passives is already taking place and the new guidelines may not have big incremental changes and even smart beta funds do not get any special push, so they will grow, but not exponentially as seen even in larger global markets," said Anil Ghelani, head of passive investments & products at DSP Mutual Fund.
"Factor-based funds form a very tiny portion of the US’s mutual fund AUM. It will grow in India, but maybe at a relatively slower pace," he added.
The number of launches and investor folios in passive schemes has increased sharply. Over the past five years, passive assets under management have risen from 7.3% of total mutual fund assets to 19.02% as of January, according to Amfi. Passive assets under management now stand at ₹15.41 trillion.
“The last two-three years saw a lot of new funds come through in passives as the segment is growing. There are already a lot of flexibilities in the passive space. This will remain,” said Ghelani.
Poor performance
Mint reported in February that several AMCs now view passive funds as a standalone business opportunity, prompting them to set up dedicated teams to manage and service the segment. The shift is a consequence of the lacklustre performance of active funds.
More than 80% of large-cap funds failed to outperform their benchmarks over the five years through the first half of FY25, according to the latest S&P Global SPIVA report, which measures the performance of actively managed Indian funds against their respective benchmarks. About 60% of mid- and small-cap funds underperformed during the same period.
“India will follow developed nations like the US. The US has more than 50% of its AUM in passives. We are likely to follow the same path,” said Doshi of Prabhudas Lilladher.
Passives form 54% of total mutual fund assets in the US, forming the dominant category of investments for retail participants as of July 2025, according to a report by DSP Mutual Fund.