In recent years, the trend of passive investing has made a significant impact on the Chinese capital market, energizing a variety of market participants, including medium and small public offering (public fund) institutionsMany of these institutions, once hesitant, are now stepping into the wave of passive investment that has taken the industry by storm.

What’s notable is the resurgence of small and medium-sized public funds in launching index funds after a five-year hiatus, particularly characterized by their attempts to carve out a niche in a market heavily dominated by larger playersThe central question remains: can these smaller funds successfully capitalize on passive investment, or will they merely trail behind the major firms?

With the launch of index funds tracking the CSI A500 index, there has been a noticeable increase in interest around passive investing

A fresh wave of public funds has emerged, with several institutions such as PuYin Ansheng Fund, Zhongjin Fund, and Dongcai Fund recently announcing their plans for CSI A500 ETFs, marking the beginning of a new chapter in their investment approach.

Moreover, the current momentum is expected to draw more public funds into the foldSince December, companies like Shangzheng Fund, Taiping Fund, Xinhua Fund, Anxin Fund, and others have submitted applications to the China Securities Regulatory Commission (CSRC) for CSI A500 index-related funds.

Unlike their larger counterparts that took an early lead in passive investments, it’s interesting to observe that many of the participating smaller public funds are less established and are still navigating their positionsThese mid to small-sized institutions often have assets under management of less than 10 billion yuan, underscoring the challenge they face in competing for market share.

The surge in popularity of the CSI A500 index fund reflects the heightened enthusiasm for passive investing within China’s public fund sector

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This year, for the first time in history, we are witnessing medium and small public funds vying for position alongside their larger peers, creating a truly competitive environment.

As the passive investing market expands, skepticism is fading among previously cautious institutionsA notable shift is that many who once focused solely on active investing are now reentering the passive arena.

For example, Guotou Ruijin Fund, having not launched any index funds since June 2019, has recently introduced two new products: the Guotou Ruijin CSI Robotics Index Fund and the Guotou Ruijin CSI Hong Kong Stock Connect Central Enterprise Dividend Index FundSimilarly, Anxin Fund’s last index fund launch can be traced back to December 2019, but they are now moving forward with their application for the Anxin CSI A500 Index Enhanced Fund slated for December 10, 2024.

The evolving landscape of passive investment also highlights a significant Matthew effect, as larger funds continue to prevail in a highly competitive environment, often leaving smaller players struggling to find their footing.

Interestingly, many of these mid to small-sized public funds are not simply chasing trends; they are carefully positioning themselves to leverage their unique strengths

This year, their approach has largely revolved around a strategy encapsulated in the phrase “one not to pursue, three to engage.” Specifically, they are avoiding majority competition in ETF business while focusing on enhancing exposure, sector-based thematic investing, and high-dividend index products.

In this current phase of passive investment, the trend has seen many smaller public funds steering clear of the crowded ETF space—often seen as a high-stakes market requiring extensive resources and with low immediate returnsThe ten largest firms in this category dominate over 80% of non-money market ETF market share, making it tough for smaller players to match up against established brands and market muscle.

This communication was echoed by a well-known investment director in South China who pointed out the inherent first-mover advantages in the ETF market, where only a couple of firms in a specific niche can accumulate significant market share, often leading to a grim outlook for smaller products

A survival of the fittest concept is palpable, with smaller funds often falling by the wayside.

Considering barriers to entry, ETFs typically have a minimum asset requirement of 20 million yuan, whereas out-of-market index funds offer smaller public funds an easier path to establishmentThese funds can initially form through the establishment process with lower barriers, allowing for a quicker response to growing market demands for index products.

Upon examining the offerings from smaller public funds this year, it’s clear they have gravitated towards three major categories: enhanced index, sector-themed, and high-dividend index products.

This trend is further reinforced by the recent push for enhanced index funds under the CSI A500 initiative, with funds like Guojin Fund and Huashang Fund taking the lead in launching enhanced index fundsFirms like Xingzheng Global Fund, Galaxy Fund, and Shenwan Hongyuan Group are already in the process of launching their products while many others await the green light.

While several industry professionals have expressed concerns that a strong emphasis on passive strategies contradicts the pursuit of alpha, advocates for enhanced index funds counter that these products can indeed generate excess returns through superior research and investment management capabilities.

Moreover, some mid to small public institutions are creatively leveraging their research advantages to issue unique thematic index funds, such as Guotou Ruijin’s robotics index fund and Rongtong Fund’s technology-focused Hong Kong Stock Connect index.

Amid a backdrop of dwindling risk-free rates, many smaller funds are also capitalizing on the favorable dividend yield of high-dividend stocks

Funds such as Changcheng Fund's CSI Dividend Low Volatility 100 Index Fund and Xinyuan Fund’s Xiangyuan Huazheng Hong Kong and Shanghai Dividend 50 Index Fund are a testament to this evolving strategy.

Moreover, some fund managers note that by launching index funds, they can diversify their product offerings and counterbalance outflows they experience in their active equity funds, helping to mitigate overall decline in fund sizes and enhancing stability.

Interestingly, many smaller public funds are gravitating towards enhanced index, sector-themed, and high-dividend funds due to their complementary natureEnhanced index funds straddle the line between active and passive investing, making them versatileSector-themed typically sees higher growth potential due to thematic investing, while high-dividend funds provide a reliable returns structure.

However, as more smaller public funds enter the passive investment space, there is an inherent risk of them becoming mere followers in a saturated market

Some funds are still directing resources towards widely popularized broad-based index funds or engaging in the competitive ETF arena, with many rolling out indistinguishable products that fail to gain market traction.

Leading voices in the industry suggest that public funds should seek differentiated competitive strategies based on their specific advantages to minimize product redundancyMoreover, a focus on quality and tailored products in designing offerings can appeal to specific market needs.

In this context, the capacity for public funds to explore innovative avenues in investment selections is vitalThere's a broad spectrum of untapped potentials within domestic passive investment opportunities, as the CSRC recently launched several new indices targeted towards enhancing investment alternatives.

Continued growth in the index sector is anticipated, particularly as greater market demand and support from regulatory bodies enhance the ecological balance of index investing in China