Family offices tap index, passive funds to boost wealth creation

SEBI mandated benchmarking returns against the total return index instead of the price index, revealing that many fund managers were not outperforming their benchmarks.

Family offices, which are set up to manage the wealth of rich and ultra-rich families, have been steadily increasing their allocation to the mutual fund segment as well with a special focus on index and other passive schemes.

This is an interesting trend as mutual funds are generally looked upon as an investment avenue for retail investors – at least the active and passive equity funds – and family offices typically deal with huge corpus of money and have the option to invest across asset classes.

Incidentally, a recent report by Tata Mutual Fund highlighted that passively managed funds have seen a rapid increase in their assets under management (AUM) and seen their share as a percentage of the overall industry AUM rise rapidly from 2.01 percent in FY16 to 17.02 percent in FY24.

Pratik Oswal, Director, Head of Passive Funds Business at Motilal Oswal AMC, says that institutions and family offices are now considering passive investments for a significant part of their allocation, shifting from fixed-income to equities, including products like the Nifty 50, Nifty 500, or Factor Funds.

Similarly, Nishant Agarwal, Senior Managing Partner & Head – Investment Advisory and Family, ASK Private Wealth, says that the appreciation for passive or index funds has significantly increased over the last three years among all investor classes.

“This shift is partly due to many active fund managers struggling to outperform indexes amidst sector rotations in public sector banks, real estate, materials, and infrastructure, which have outperformed consumption, private banks, and some NBFCs. Consequently, family offices and HNI investors are increasingly considering passive funds as part of their portfolios,” he says.

Growth in allocations

Meanwhile, allocations vary by client type and risk appetite. Mukesh Jindal of Alpha Capital, a multi-family office, says that 30 percent of their AUM is in index funds, 25-30 percent in active mid and small-cap funds, 20 percent in fixed income, and 15-20 percent in private alternatives.

At ASK Private Wealth, passive funds previously accounted for 5-10 percent of equity allocations which has now risen to 25-30 percent. This trend, says Agarwal, is observed not just in ASK's portfolios but broadly in the overall market as well.

Jindal is of the view that the trend picked up after the pandemic in 2020, growing from 5-10 percent previously, driven by increased awareness and product variety.

What has been behind this shift

Industry experts attribute this shift to regulatory changes by SEBI as well, highlighting the changes between 2017 and 2019.

SEBI mandated benchmarking returns against the total return index instead of the price index, revealing that many fund managers were not outperforming their benchmarks. This, experts say, led to knowledgeable investors, including institutions, to shift from active to passive schemes.

Vishal Jain, CEO of Zerodha Fund House, explains while adding that investing in passive funds is also simple and cost-effective.

“With numerous fund managers, predicting outperformance is challenging as different managers excel at different times,” he says.

Index funds have also consistently performed relative to their benchmarks, drawing family offices away from actively managed funds, especially in the large-cap segment. The cost efficiency of index funds, with lower expense ratios, has been a major attraction, say industry players.

Another area that has caught the eye of family offices has been factor funds or active passive funds.

“The principle change, among others, has also been introduction of what we call as active passive funds, which are also known as factor-based index funds, such as low volatility fund, momentum funds etc.,” notes Saket Lakhotia, Senior Executive Director - Wealth, Client Associates.

Divij Chopra, Managing Director at Waterfield Advisors adds that the period between December 2023 and May this year saw the AUM in smart beta strategies increase by 96 percent, rising from about Rs 7,800 crore to Rs 15,300 crore.

“This growth is due to the popularity of passive plus strategies. We see substantial allocations to NIFTY 50, NEXT 50, small, and mid-cap funds, which as a category have grown by approximately 50% year on year for the last 6 years,” he says.

While there has been growth across areas, smart beta has experienced the most significant increase, albeit of a smaller base. “When evaluating managers for family offices, we consider both active and passive/passive plus strategies; on the latter we pay close attention to their AUM size. We are also seeing more AMCs entering this (Passive Instrument) space, and that is testament to its growth and outlook", he says.

There is also growing interest in sectoral and thematic index funds, catering to specific market segments and investment themes, allowing family offices to tailor their strategies according to specific trends.

Lakhotia explains, that in the thematic category, most investments are in index-specific funds with typically, 5 to 15 percent of equity allocations going into thematic or sectoral funds, depending on available opportunities.

Globally as well, family offices are increasingly investing in overseas index funds and ETFs to diversify portfolios and gain exposure to international markets and thematic investments like clean energy, biotech, and AI.

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