Mutual funds provide a means to retail investors to participate in equity investment without knowing the nuances of the stock market in details. The objective is to take advantage of higher returns that equity provides over other investment channels in the long term. If this the backdrop should one invest in
index funds?
For uninitiated, index funds are passive funds that mirror an index like Nifty or Sensex. Thus your return on your investments is not dependent on the expertise of fund managers. Moreover, cost structure (expense ratio) of index funds are much less than active funds as administrative costs are less.
But as a retail investment shouldn’t you be taking advantage of expertise of fund managers in active funds? In a growing market like India, there are many pockets of opportunity outside index which are not well research but provide potential for huge upside. But is that happening in practice? Are active funds providing returns well above corresponding index funds to justify their cost structure?
Recently Standard & Poor's (S&P) has come out wi th a scorecard, S&P Indices versus Active Fund (SPIVA) scorecard for the Indian mutual fund industry. The scorecard reveals that benchmark indices have outperformed a majority of funds in most categories across a number of observed time frames. The study by S&P and CRISIL has compared the performances of the Indian mutual funds across time periods such as 1 year, 3 years and 5 years as on 31 December 2009. According to the scorecard, 70% of large cap funds in India underperformed the S&P CNX Nifty Index while 40% of the funds in the diversified equity category underperformed the S&P CNX 500 Index over a 5-year period ended Dec 2009. The scorecard has also revealed that almost 80% of the Equity Linked Savings Schemes (ELSS funds) underperformed during the 1 and 3 year periods. When it comes to 5 years period 65% of funds have failed to outperform the benchmark.
This implies while some active funds many outperform index funds till Indian market matures, it will become more and more difficult for fund managers to do the same over long run after adjusting higher expense. Thus for retails investors who wants to stay investor for long haul, index funds should be part of their core portfolio along with active funds. Moreover, due diligence should be done while choosing active funds, look for funds which are consistently giving more returns than index in its category over term (3,5 and 10 years).
For retail investor while it make sense to take advantage of higher returns of active funds with consistent history
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index funds?
For uninitiated, index funds are passive funds that mirror an index like Nifty or Sensex. Thus your return on your investments is not dependent on the expertise of fund managers. Moreover, cost structure (expense ratio) of index funds are much less than active funds as administrative costs are less.
But as a retail investment shouldn’t you be taking advantage of expertise of fund managers in active funds? In a growing market like India, there are many pockets of opportunity outside index which are not well research but provide potential for huge upside. But is that happening in practice? Are active funds providing returns well above corresponding index funds to justify their cost structure?
Recently Standard & Poor's (S&P) has come out wi th a scorecard, S&P Indices versus Active Fund (SPIVA) scorecard for the Indian mutual fund industry. The scorecard reveals that benchmark indices have outperformed a majority of funds in most categories across a number of observed time frames. The study by S&P and CRISIL has compared the performances of the Indian mutual funds across time periods such as 1 year, 3 years and 5 years as on 31 December 2009. According to the scorecard, 70% of large cap funds in India underperformed the S&P CNX Nifty Index while 40% of the funds in the diversified equity category underperformed the S&P CNX 500 Index over a 5-year period ended Dec 2009. The scorecard has also revealed that almost 80% of the Equity Linked Savings Schemes (ELSS funds) underperformed during the 1 and 3 year periods. When it comes to 5 years period 65% of funds have failed to outperform the benchmark.
This implies while some active funds many outperform index funds till Indian market matures, it will become more and more difficult for fund managers to do the same over long run after adjusting higher expense. Thus for retails investors who wants to stay investor for long haul, index funds should be part of their core portfolio along with active funds. Moreover, due diligence should be done while choosing active funds, look for funds which are consistently giving more returns than index in its category over term (3,5 and 10 years).
For retail investor while it make sense to take advantage of higher returns of active funds with consistent history
Related articles:
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