The Role of ETFs in Passive Investing Strategies in India

The Passive Shift: Beyond the Basics

By design, passive investing aims to replicate the performance of a specific index rather than try to outperform it. While this approach was slow to catch on in India due to the past outperformance of active funds, the consistent underperformance of many active mutual funds against their benchmarks in recent years has brought ETFs into the spotlight.

According to AMFI data, the AUM in ETFs has surged from just ₹11,000 crore in 2015 to over ₹6.5 lakh crore in 2025 (YTD), indicating a paradigm shift among institutions and increasingly among HNIs and retail investors.
 

Strategic Role of ETFs in Indian Portfolios

1. Core Portfolio Building Block

ETFs are now being used to construct the core portfolio, especially for long-term asset allocation strategies. Index ETFs like Nifty 50, Nifty Next 50, and Sensex are increasingly preferred due to their low cost, transparency, and simplicity. Asset managers and financial advisors now consider ETFs a baseline portfolio component for clients with a long-term investment horizon.

Example: A retail investor looking to maintain a 60:40 equity-debt allocation might hold the Nifty 50 ETF for equity and the Bharat Bond ETF for fixed income.

2. Smart Beta and Factor-Based Strategies

India has witnessed the introduction of smart beta ETFs tracking strategies like value, momentum, quality, low volatility, and equal weight. These ETFs blend the cost-efficiency of passive investing with factor-driven alpha generation.
Institutional investors in India have started using smart beta ETFs to tilt portfolios toward outperforming factors during different market cycles.

Example: During high volatility phases, investors might prefer a Low Volatility 30 ETF, while in a trending bull market, a Momentum 30 ETF could outperform the broad index.

3. Sectoral and Thematic Rotation

One of the most underappreciated yet impactful uses of ETFs in India is sector rotation. With the launch of ETFs focused on sectors such as banking, IT, FMCG, and infrastructure, investors can now tactically overweight or underweight sectors based on macroeconomic views, earnings expectations, or regulatory developments.

Example: During the post-COVID recovery phase, savvy investors rotated into Nifty Bank ETF and PSU Bank ETFs, capitalising on credit growth and re-rating.

4. Tactical Asset Allocation (TAA)

Professional investors in India increasingly use ETFs for short-term tactical bets without disturbing their core holdings. This flexibility allows portfolio managers to quickly shift exposure based on news flows, monetary policy changes, or sector-specific momentum.

Example: When the RBI signaled a pause in rate hikes, many bond-focused investors tactically increased their allocation to 10-year G-Sec ETFs to lock in yields and benefit from bond price appreciation.

5. Bridging Global Diversification

International ETFs listed in India (e.g., Nasdaq 100, S&P 500 ETFs) offer Indian investors a gateway to geographic diversification without opening global accounts or dealing with LRS (Liberalised Remittance Scheme) limits.
While regulatory caps exist (limits on fund house exposure to foreign ETFs), these products are increasingly being used to hedge against INR depreciation or to participate in global tech and healthcare booms.

6. Cost Advantage and Performance Reality

Passive investing’s most considerable appeal—low cost—is even more relevant in India, where the cost delta between active and passive is significant. Most equity ETFs charge 0.05%–0.10% TER, while active equity funds average over 1.5%.
More importantly, the SPIVA India Scorecard 2024 reveals that over 80% of large-cap active funds underperformed their benchmark over 5 years, making a compelling case for index investing via ETFs.
 

Who Is Driving ETF Growth in India?

EPFO (Employees’ Provident Fund Organisation): One of the biggest buyers of Nifty and Sensex ETFs.

• Corporate Treasuries: Seeking cost-effective instruments for equity exposure.
• Retail via Discount Brokers: Thanks to platforms like Zerodha and 5paisa, ETFs are easily accessible and tradeable like stocks.

RIAs & Fee-Only Planners: ETFs are increasingly recommended to eliminate conflicts of interest tied to commissions.
 

Challenges & Considerations

Despite their growing popularity, ETFs in India still face several limitations:

• Liquidity constraints in niche ETFs (especially thematic ones).
• Tracking error in debt ETFs, particularly during volatile interest rate phases.
• Limited awareness and low ETF penetration in tier-2 and tier-3 cities.

To mitigate this, SEBI and AMFI have recently started promoting ETF literacy, while brokers now show real-time NAV tracking and better ETF screeners.
 

Future of ETFs in Indian Passive Investing

India is still in the early innings of an ETF revolution. The next wave is likely to be driven by:

• Increased innovative beta product launches
• ETF-based retirement and goal-based portfolios
• More active-to-passive fund transitions
• Inclusion of ETFs in robo-advisory and wealth-tech platforms

SEBI’s push for passive-only fund-of-funds and the growth of target maturity debt ETFs (for a laddering strategy) will further deepen ETF utility in long-term financial planning.
 

Final Thoughts

ETFs are no longer mere index replicators in India—they’re versatile tools for active tactical strategies, cost optimization, global exposure, and factor-driven alpha generation. As investor awareness matures and more innovation enters the space, ETFs will play an increasingly strategic role in retail and institutional passive investing in India.