After seeing a significant number of passive funds launches in 2024, India is in the early stages of a shift towards passive funds, says Kunal Kapoor, CEO, Morningstar.

"In the US, passive funds surpassed active strategies in assets under management by the end of 2023, following years of consistent net inflows. While India is in the early stages of this trend, the shift towards passive is undeniable," he says in this interview with ETMarkets. Edited excerpts:


How do you see the mutual fund industry evolving in India? SIP inflows have been at record high but as we step into a slowdown phase with equity returns moderating, could retail investor expectations be a major hiccup in the journey?
The Indian Mutual Fund industry has come a long way over the past decade. Proactive regulations on disclosures, fund categorization and fees have driven positive change. Increased retail investor participation has also been fuelled by the industry’s efforts to promote investor awareness and education, broadening the reach of mutual funds across the country and investor segments.

Systematic investing into the equity markets through SIPs has created a culture of long-term disciplined investing, which we believe is here to stay. While equity markets will naturally experience crests and troughs, we believe investors are better equipped to handle this and stay focused on their long-term goals.

Do you think SIP inflows can cross the Rs 1 lakh crore monthly mark by the end of this decade in 2030?
SIPs have been the bedrock of domestic flows into the Indian equity markets. It is encouraging to see the mutual fund penetration growing across the country, with more participation from smaller cities and younger investors. We expect this momentum will continue as newer investors turn to mutual funds. While it is difficult to predict when the mark of lakh crore will be achieved, the industry is headed in the right direction.

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With Trump administration taking charge, how do you see the US Fed rate cut cycle shaping up in 2025? A delayed rate cut can impact FII flows into India as well.
While inflation remains somewhat sticky, many economists expect price pressure to soften in the coming months, supported by healthy economic growth and a resilient labour market.

Analysts say tariffs and tighter immigration rules could exacerbate price pressures, however looser regulations and a protectionist agenda could spur growth in the US. For now, the Fed is expected to remain cautious, waiting for more clarity on these factors.

Looking ahead, the consensus among economists is for one or two quarter-point rate cuts later in the year, depending on progress in cooling inflation and any signs of softening in the labour market. While the Fed appears to be in “wait and see” mode, any delay in rate cuts could potentially impact FII flows into India.

Given how generative AI is finding its place in all spheres of life, where do you think it fits in for mutual fund investors? Also, how is Morningstar utilizing AI to serve the needs of its clients better?
AI is becoming an integral part of everything we do. We are actively integrating AI into our workflows to enhance investor outcomes and deliver more personalised, data-driven solutions. For mutual fund investors, AI holds great potential as an enabler, helping investors assess risk more accurately, and optimise investment decisions. At Morningstar, we see AI as a powerful tool to meet the evolving needs of our clients.

With the launch of multiple new ETFs and index funds across themes, passive investing is gradually picking up pace in India. Aren't we on the path where passive-active will have 50-50 market share, if not more?

Passive investing is gaining momentum in India. While it initially attracted institutional investors such as EPFO, we’ve recently seen growing interest from individual investors especially in index funds. In 2024, we saw a significant number of passive funds launches. In the US, passive funds surpassed active strategies in assets under management by the end of 2023, following years of consistent net inflows. While India is in the early stages of this trend, the shift towards passive is undeniable.

One view in the Indian market is that it is getting tougher for active fund managers, especially those in the large-cap category, to keep outperforming their benchmarks. Is it the same story in the US market as well?

In the US, the large-cap equity market has long posed challenges for active managers. Over the decade ending June 2024, only 20% of active large-cap funds in the US market managed to both survive and outperform their average passive peers, compared to 27% for mid-cap funds and 38% for small-cap funds.

However, over the 12 months through June 2024, 53% of active large-cap equity funds outperformed their index-tracking peers. Notably, active large-growth portfolios entering July 2023 were more concentrated, benefitting from the market rally driven by a handful of high-performing mega-cap stocks over the following year.

Indian funds, especially large-cap funds have also witnessed a similar trend over the past few years, with the percentage of large-cap funds outperforming their passive peers coming down. As industry assets continue to grow and funds own a higher percentage of the overall Indian market cap, this number may shrink further.

If someone is buying a largecap mutual fund, is it better rather to go for a broader based index fund/ETF or a combination of Nifty50 and Nifty Next50?
While the choice of an index fund will depend upon an individual’s risk profile and portfolio needs. Here is a list of traits to look for when evaluating index funds:

• Representative: The index fund should provide the full range of opportunities available to its actively managed fund peers.

• Diversified: A wide array of holdings should be on offer.

• Investable: It should invest in liquid securities that are easy to track.

• Transparent: The fund should track a clearly defined index that allows investors to anticipate its behaviour across market environments.

• Sensible: Portfolios should be driven by sound economic rationale.

• Low Turnover: Any portfolio turnover is limited and managed by the index.

• Fees: Lower the expenses the better
  

What are Morningstar’s plans for growing in India given the fact that the wealth management industry has been on a boom and there is a rising interest beyond mutual funds into newer avenues like PMS, private markets, alternative investments, etc?
At Morningstar, we are actively pursuing opportunities in India’s wealth management space, aligning with its rapid growth and evolving client needs. We are investing in resources and innovative strategies to empower wealth managers with scalable, tech-driven solutions. Leveraging our capabilities such as Data, the Direct platform, and advanced analytics, we aim to equip wealth managers with tools and insights to navigate both traditional and emerging investment avenues, including PMS, private markets, and alternative investments. Additionally, we are enhancing our offering to include comprehensive data on PMS and alternative funds, ensuring wealth managers have access to the most relevant information to best serve their clients.

SEBI has proposed a new vehicle for investing - Specialised Investment Fund (SIF) - which will fill in the gap between mutual funds and PMS schemes. What are your thoughts on how popular the new vehicle can turn out to be?
Liquid Alts have gained traction as investors increasingly look beyond traditional funds for more flexible and innovative solutions. In India, as the market continues to mature, there is a natural progression for investors to seek products that bridge the gap between mutual funds and PMS schemes. These funds can potentially provide exposures and risk diversification which investors may not have access to through traditional funds.