Passive investing eliminates unsystematic risk from portfolio: Sundeep Sikka3 min read . Updated: 23 Dec 2020, 11:21 AM IST
The investors who could be courageous to invest in stock markets during March and April 2020 would be sitting on handsome profits, but is the opportunity lost for the investors planning to invest now?
Nobody would have thought that in the first half of the year 2020 that stock markets would make a strong rebound in the second half, touching the new all-time highs. The investors who could be courageous to invest in stock markets during March and April 2020 would be sitting on handsome profits, but is the opportunity lost for the investors planning to invest now? While the markets may seem to be overvalued presently, the higher levels are still getting sustained. With EPS flat and valuations sustaining nearing all-time highs, the coming times can be expected to be an exciting story for the investors with a multiple expansion vis-à-vis re-rating story getting written on the walls.
While the liquidity into the markets may be driving the present rally, the cost of funding has also declined considerably for the Corporates due to the easing of the monetary policy rates and stimulus relief making its way into the credit markets. The consumption space has been seeping its way steadily into normalcy, and barring one or two sectors, the pre-covid levels of activity have been encouraging signs of economic revival. No wonder we are at an inflection point with the market outlook continuing to be optimistic.
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Even when the broad consensus for the stock markets is positive, there would always be select pockets that would underperform the markets and some segments which would outperform. Massive divergence in equities since the beginning of 2018 as returns have been concentrated in a few stocks and sectors. The present rally was largely supported by the large caps, while the mid cap and small caps have underperformed. Such polarization is well depicted by the divergence in the performance of Nifty indices & Nifty Equal Weight indices. Which sector will outperform next continues to be anybody's guess. Even historically, no single market cap segment has been a consistent winner.
The investors tend to prefer investing in mutual fund schemes with the flexibility to invest across market caps instead of staying within a particular market capitalization segment. The data released by the Association of Mutual Funds in India (AMFI) for November 2020 reflects that multi-cap funds are the second most popular category of equity schemes with an AUM (Assets Under Management) of more than Rs. 1.60 lakh crore.
However, even within the multi cap space, the divergence of performance of different funds can make the art of picking the right mutual fund scheme difficult. Given the stark divergence amongst the funds' performance and given the tough task of spotting the winners in different categories, the investors can instead opt for passive investing and trust the stock markets' collective wisdom. Passive investing helps the investors eliminate the unsystematic risk from the investment portfolio and provides a cost-effective way of investing in markets.
Passive investing is not only a prudent manner to invest in stock markets but can also be expected to contribute to the increasing mutual fund penetration in the country. Such investing can be done through Exchange Traded Funds (ETFs) or Fund of Funds (FoFs). While ETFs track benchmark indices, FoFs tend to invest in other mutual fund schemes as per the investment objective and mandate. As such, ETF investing aims to replicate the performance of the scientifically-constructed and back-tested benchmark indices;the investors in FoFs rely on the wisdom of the respective fund managers. With the decision-making process predominantly relying on different fund managers, the investment portfolio will depend upon the market consensus instead of a single fund manager's outlook. Keeping the unsystematic risk at bay, the investors can aim to generate better returns through the markets' collective wisdom with FoF investing.
(The author is ED and CEO, Nippon India Mutual Fund. Views expressed are his own.)