Why Passive Funds Have Limited Share in India Despite Growing AUM

Passive funds in India have shown remarkable growth in assets under management (AUM), rising from Rs.6.64 lakh crore in February 2023 to Rs.15.24 lakh crore in February 2026, according to Association of Mutual Funds in India (AMFI) data. However, when viewed as a percentage of the mutual fund industry's total AUM, the growth appears more modest—increasing from 16.8% to just 18.6% over the same period.

The latest AUM breakdown shows gold exchange-traded funds (ETFs) at Rs.1.83 lakh crore, index funds at Rs.3.25 lakh crore, and other ETFs (non-gold, including debt) at Rs.9.76 lakh crore, with the remainder in fund of funds investing overseas.

The article outlines several advantages of passive funds. Their primary benefit is the lower total expense ratio (TER) compared to actively managed funds, since fund manager intervention is minimal. More importantly, passive funds don't need to outperform the benchmark—they simply track it. While active funds can generate alpha even after expenses, passive funds protect investors against underperformance when fund manager calls go wrong.

Additional benefits include access to smart beta strategies and international diversification through passive products.

However, three key factors limit passive fund growth in India. First, financial literacy remains concentrated in tier-1 cities and select pockets of tier-2 and tier-3 areas. The AMFI-CRISIL Factbook reveals that as of March 2024, nearly 80% of passive fund AUM was held by corporate investors, while individual investors held just 19.4%—13.8% with high net-worth individuals (HNIs) and only 5.6% with retail investors.

Second, investor optimism drives preference for active funds. Many investors believe their fund will outperform the benchmark post-expenses, and some active funds do beat the benchmark, though less than 50% achieve this.

Third, the distributor ecosystem favors active funds. With around 45% of MF investments via direct channels (already aware of lower TER), the remaining 55% through regular plans requires distributor push. Active funds provide higher incentivization through greater expenses, making them more attractive to distributors.

The article concludes that investors should consider a core-satellite approach—using passive funds for long-term large-cap exposure (the core) where outperformance is difficult, and active funds for tactical allocations in small cap or thematic segments (the satellite) where fund manager skills can generate alpha.