Passive Investing in India: Index Funds, ETFs, and What Investors Should Know

Passive investing used to be a niche idea in India. A few institutional investors, a handful of ETFs, and limited retail awareness. That picture has changed significantly. As of February 2026, passive funds account for roughly 17% of total mutual fund AUM in India, managing over ₹15 lakh crore in assets across index funds, ETFs, gold funds, and fund of funds.

The shift is not accidental. A combination of cost pressure, growing data on active fund underperformance, and broader investor awareness has made passive products more relevant to a wider range of investors. This article explains what passive investing means, why it has gained momentum in India, how different passive products work, and what investors should keep in mind before using them.

What Is Passive Investing and How Does It Work?

Passive investing means tracking an index rather than trying to beat it. A passive fund, whether an index fund or an ETF, buys the same stocks as its benchmark index in the same proportions, and holds them as long as those stocks remain in the index.

The objective is not to outperform the market. It is to deliver returns that closely match the index, at the lowest possible cost. The primary measure of how well a passive fund does this job is called tracking error. The smaller the gap between the fund's returns and the index's returns, the better.

Because there is no active stock selection involved, passive funds carry significantly lower costs than actively managed funds. Some Nifty 50 ETFs in India now operate with expense ratios as low as 0.02% to 0.05% per year, compared to active large-cap funds that typically charge between 1% and 2%.

Passive Fund Growth in India: How Far Has It Come?

The scale of passive fund growth in India becomes clear when you look at the data over time. As recently as FY17, passive funds accounted for just 3% of total mutual fund AUM. That share grew rapidly to around 17% by FY23, driven primarily by institutional flows into ETFs and growing retail awareness of index funds.

The growth has been led by equity ETFs, which account for the majority of passive AUM, followed by index funds. Gold ETFs have also seen a surge in recent years, driven by strong precious metal prices. Within passive products, ETFs have grown faster than index funds, primarily because of their listing advantage and typically lower expense ratios.

Why Are Passive Funds Gaining Ground in India?

Two factors, more than any other, have driven the shift toward passive investing in India: cost and performance data.

Active large-cap funds have consistently underperformed their benchmarks

The SPIVA India Scorecard, published by S&P Dow Jones Indices, tracks how actively managed Indian mutual funds perform against their benchmark indices over different time horizons. The findings across years have been consistent.

For large-cap funds, the picture is particularly stark. SPIVA data shows that around 65% to 85% of active large-cap funds in India underperform their benchmark over one-year, three-year, and five-year periods. The underperformance rate at the five-year horizon has at times crossed 90%.

Two structural reasons explain this. First, large-cap stocks are heavily researched - hundreds of analysts track the same companies, so pricing is relatively efficient and there is little undiscovered information for fund managers to exploit. Second, SEBI limits mutual funds to a maximum 10% exposure to any single stock, which restricts concentration in the few stocks that drive most index returns in a given period.

The cost gap between passive and active funds compounds over time

Active large-cap funds in India typically carry expense ratios between 1% and 2% per year for regular plans. Nifty 50 index funds and ETFs in direct plans now operate at 0.10% or below, with some ETFs charging as little as 0.02% to 0.05%.

That gap compounds significantly over long holding periods. A fund delivering 10% gross returns but charging 1.5% in fees leaves the investor with 8.5%. An index fund delivering the same 10% gross but charging 0.10% leaves 9.9%. Over ten or fifteen years, that difference in compounding creates a meaningful gap in final corpus value.

This cost arithmetic has become more visible to investors as financial literacy improves and direct plan data is more widely accessible.

Does the Passive Argument Hold Outside Large Caps?

The case for passive investing is strongest in the large-cap space. Outside it, the picture changes.

In mid-cap and small-cap segments, markets are less efficiently priced. Analyst coverage is thinner, and skilled fund managers have more opportunity to identify companies before they are widely tracked. SPIVA data shows that the percentage of active funds underperforming their benchmarks is lower in mid-cap and small-cap categories than in large-cap. That said, outperformance is not guaranteed and results vary significantly across years and funds.

This is why passive funds do not replace active funds across the board. For many investors, a combination of both - passive exposure to large-cap markets and selective active exposure in mid-cap or small-cap segments - may be more appropriate than a purely passive or purely active approach.

Types of Passive Funds Available in India

Passive investing in India is not limited to a single product type. Several structures are available, each with different mechanics and use cases.

Equity index funds

These track domestic equity indices such as the Nifty 50, Sensex, Nifty Next 50, Nifty 100, Nifty Midcap 150, or Nifty 500. They can be bought and sold at end-of-day NAV, like any other mutual fund. They do not require a demat account and are well-suited for SIP investing through standard investment platforms.

Equity ETFs

ETFs track the same indices as index funds but trade on stock exchanges at real-time prices, like shares. They typically have lower expense ratios than index funds but require a demat account and brokerage account to purchase. Liquidity varies across ETFs, so bid-ask spreads matter for investors transacting in smaller amounts.

Sectoral and thematic index funds and ETFs

These track specific sectors such as banking, IT, or infrastructure, or thematic indices like defence or manufacturing. They carry higher concentration risk than broad-based index funds and are more susceptible to cyclical swings within a sector. Investors considering these should have a clear view on why that sector exposure fits their portfolio.

Debt index funds

These track government securities or corporate bond indices, offering low-cost fixed income exposure. They are useful for investors who want debt exposure with transparency about portfolio composition, without relying on a fund manager's duration or credit calls.

Gold ETFs

These track domestic gold prices and offer a regulated, transparent way to hold gold within a portfolio. Gold ETFs require a demat account. They differ from gold mutual funds, which are fund of funds that invest in gold ETFs and do not require a demat account, in both cost and transaction mechanics.

Three Practical Uses of Index Funds in a Portfolio

What to Check Before Investing in Passive Funds

Not all passive funds are equal

Two index funds tracking the same index can deliver different outcomes over time. The differences come from expense ratio and tracking error. A fund with a lower expense ratio and lower tracking error will, all else equal, deliver a better outcome for a long-term investor. Both metrics are disclosed by fund houses and available on AMFI's website.

Be cautious of products that claim to improve on the index

Some products are marketed as enhanced index funds or smart beta strategies that claim to beat the index while remaining low cost. These involve active factor tilts and carry tracking risk relative to the index. They are not the same as a pure passive fund and should be evaluated on their own merits before use.

Passive does not mean risk-free

An index fund delivers the returns of the index, which also means it delivers the losses of the index. A Nifty 50 index fund will fall in line with the market during periods of correction. Passive investing reduces fund-manager risk and cost drag, but it does not eliminate market risk. Investors should have an appropriate holding horizon and asset allocation to manage this.

Passive is a tool, not a complete strategy

Passive funds work best as part of a broader, goal-linked portfolio. Many investors use passive funds for core large-cap exposure and active funds in mid-cap or small-cap segments where skilled managers may add more value. The right mix depends on an individual's goals, time horizon, and risk tolerance.

Key Takeaways

• Passive funds in India have grown from 3% of total mutual fund AUM in FY17 to approximately 17% by 2026, reflecting a structural shift in how Indian investors allocate money
• The case for passive investing is strongest in large-cap equity, where SPIVA data shows 65% to 85% of active funds underperform their benchmarks over most time horizons
• Cost is the primary structural advantage of passive funds - leading Nifty 50 ETFs now charge as little as 0.02% to 0.05% in expense ratio, compared to 1% to 2% for active large-cap funds
• The passive argument is less clear-cut in mid-cap and small-cap segments, where markets are less efficiently priced and active managers have more scope to add value
• When selecting a passive fund, expense ratio and tracking error matter more than the fund house name - two funds on the same index can deliver meaningfully different outcomes over time

FAQs

1. What is the difference between an index fund and an ETF?

Both track a benchmark index, but they differ in how they are bought. Index funds are purchased at end-of-day NAV through investment platforms and do not require a demat account. ETFs trade on stock exchanges at real-time prices and require a demat and brokerage account. ETFs typically have lower expense ratios than equivalent index funds.

2. Why do most active large-cap funds underperform their benchmarks?

Large-cap stocks are heavily researched, making it difficult to consistently find mispriced opportunities. SEBI's 10% single-stock cap also restricts active funds from concentrating in the few top performers. After fees, most active large-cap funds deliver less than the index they track.

3. Are passive funds better than active funds for all investors?

Not necessarily. Passive funds have a stronger case in large-cap equity, where active underperformance has been well documented. In mid-cap and small-cap segments, skilled active fund managers can still add value over full market cycles. Many investors benefit from a combination of both rather than choosing one exclusively.

4. What should I look for when choosing an index fund or ETF?

Two metrics matter most: expense ratio and tracking error. A lower expense ratio means more of the index return reaches the investor. A lower tracking error means the fund is accurately replicating the index. Both are disclosed by fund houses and available on AMFI's website. For ETFs, fund size and liquidity also matter.

5. Can I invest in index funds through a SIP?

Yes. Index funds support SIP investment just like any other mutual fund, on a monthly or quarterly basis. A SIP in a broad-based index fund is a straightforward way to build equity exposure over time through rupee cost averaging, without the need to time the market.

6. What is tracking error and why does it matter?

Tracking error measures how closely a fund's returns match its benchmark index. A fund with low tracking error replicates the index accurately. A high tracking error means the fund's returns deviate from the index, which can reduce the core benefit of passive investing. It is disclosed in fund factsheets and should be checked alongside expense ratio.

Disclaimer: This article is for general information and educational purposes only. It does not constitute investment advice, a recommendation, or an offer to buy or sell any mutual fund or security. Past performance of any fund category, index, or investment strategy is not indicative of future returns. Passive investing and index fund investing carry market risks. Please read all scheme-related documents carefully before investing and consult a SEBI-registered investment adviser or qualified financial professional before making any investment decision. Mutual fund investments are subject to market risks.