Passive AUM has grown at nearly twice the pace of active equity funds over the last three years. Under SEBI’s new expense regime, the gap could widen further.
A structural shift is underway in Indian mutual funds. Large-cap active managers have found it increasingly difficult to beat the benchmark, and retail investors are voting with their SIPs.
For years, the Indian mutual fund industry could point to one comforting number when debating the merits of active management: the vast majority of retail money still sat in actively-managed schemes. That number is still true, but the direction of travel has become impossible to ignore. Passive strategies — index funds, ETFs, and fund-of-funds tracking indices — now account for a rising share of industry AUM and, more tellingly, of incremental monthly inflows.
Passive AUM in India has crossed the Rs 12 lakh crore mark on the back of steady retail participation and continued institutional allocations from EPFO and NPS. Over the last three years, passive AUM has compounded at roughly twice the pace of active equity AUM. Index fund inflows in April 2025 alone were higher than in the entire calendar year 2019.
Why Active Large-Cap Managers Are Losing the Argument
The core problem for active large-cap funds is arithmetic. When the top 100 stocks are heavily researched, covered by dozens of analysts, and priced by both foreign and domestic institutions in real time, generating meaningful alpha becomes extraordinarily difficult. SEBI’s total return index (TRI) benchmarking, effective for several years now, has made underperformance harder to disguise. On a rolling three-year basis, more than half of large-cap active funds have failed to beat their benchmark, and on a five-year basis the number is not much better.
Mid- and small-cap active funds have fared better, thanks to a less-efficient stock universe and more room for genuine bottom-up work. But even here, passive alternatives — smallcap 250 and midcap 150 index funds — have started drawing flows, particularly from investors who prefer cheaper beta exposure to a category rather than picking a manager.
The New TER Regime Sharpens the Divide
SEBI’s Mutual Fund Regulations 2026, effective April 1, replace the old Total Expense Ratio with a leaner Base Expense Ratio, with GST, STT, stamp duty, and SEBI fees now charged separately. Caps for index funds and ETFs have been trimmed from 1.00 per cent to 0.90 per cent, and fund-of-funds equity from 2.25 per cent to 2.10 per cent. Active fund cost caps have also been re-examined, but the compression is more visible on the passive side, where costs were already low.
The result is that the fee arbitrage between active and passive, already meaningful, now looks even wider on paper. Direct-plan index funds are available at expense ratios below 0.20 per cent. A well-run active large-cap fund charges, on a like-for-like basis, several times that. Over a 20-year horizon, that cost differential compounds meaningfully.
Reading the Signals
- Large-cap active investing is becoming a niche argument rather than a default choice.
- Mid- and small-cap active managers still have a runway for alpha, but competition from passive alternatives is growing.
- The new TER structure widens the visible cost gap between active and passive products.
- Retail participation in index funds is deepening beyond metro investors, aided by SIP-friendly ticket sizes.
The Indian mutual fund industry is not about to become a passive-only market overnight. But the direction of the wind is now unmistakable, and the AMCs building for it are the ones investing in index platforms, ETF distribution, and low-cost passive innovation rather than defending yesterday’s active franchise.