John C. Bogle, who introduced and popularised index funds over the past four decades, died recently. His argument was that fund managers can’t do better than the average market return over the long term. Though index investing is popular in developed markets like the US, it is still in early stages in India. We spoke to experts to get a sense of what is happening on index investing, and if Indians see value in it.
Investors have begun to see benefits of index funds, ETFs
There are two dominant styles of asset management globally: active and passive. Ever since the launch of the first index fund in the US in 1976, there has been a debate between proponents of both styles.
Index funds and ETFs comprise passive investments and their popularity has grown worldwide. Indian markets are also seeing their rise as investors begin to see the benefits of investing through low-cost ETFs and index funds. Passive investing is becoming popular in India as Indian markets are turning competitive due to the presence of a large number of active asset managers such as mutual funds, insurance companies, foreign investors, PMS managers and others. Each of these entities is manned by competent managers and analysts—all of whom try to generate an alpha.
Indian data in recent times is increasingly tilting in favour of passive investing. SPIVA Scorecards (S&P Index vs. Active data) is proof.
—Vishal Jain, Head ETF, Reliance Nippon Life AMC
Active mutual funds may not continue to rule for long
Retail investors are simply looking for returns. They are not looking at whether the investment is actively or passively managed. Many don’t even know the difference between mid-cap and large-cap and just compare returns between different funds.
Currently, in the Indian market, active funds are outperforming the index on a broad basis. For that reason, people are not keen on investing in index funds as of now. But this may not remain so for long. Fund managers will have to eventually show skill in the way they pick stocks and give extra return over the index. It looks like fund managers’ outperformance going forward will be lower.
The first reason is Sebi’s recategorisation exercise; second, the total return index; and third, as the market becomes more efficient, the potential for a fund manager to outperform becomes that much less. Even in other markets, adoption of passively managed funds happened over a period of time.
—Suresh Sadagopan, Founder, Ladder7 Financial Advisories
Index funds to gain in future, but active funds here to stay
In India, index funds are yet to gain momentum. One of the primary reasons for this is the fact that active mutual funds, on an average, have been delivering returns which are better than respective benchmarks.
If one were to look at the top 25 equity mutual funds by size, at an aggregate, these funds have delivered 2% per annum return ahead of the Nifty over the past decade. This is after the management fees of these funds. This can partly be explained by the fact that mutual funds in India are relatively small, compared with the overall market and one can expect “professional fund managers" to do better than retail investors.
But 2018 seems to have been a landmark year where active funds failed to beat Nifty. Only time will tell if this is a one-off occurrence. Over the next decade, index funds will gain prominence, but given the track record, active funds are likely to deliver returns better than the index for some time to come.
—Sanjiv Singhal, Founder and COO, Scripbox
Investors don’t see value in index funds in India at present
Index funds follow passive investment strategy by replicating a benchmark index like NSE Nifty or BSE Sensex. The fund comprises of stocks in similar proportion of the benchmark. Hence, it delivers returns similar to the index.
In case of actively managed funds, the fund manager tries to generate higher return and that is measured by alpha. In developed markets, the funds managers’ capacity to generate higher alpha is constrained due to market efficiency. But in India, active fund managers have been able to generate higher alpha.
This is one of the reasons why investors do not see value in index funds in India at present. But index funds have low expenses ratio since there is no requirement of research and active management. There are also no stock-specific risks since the stocks reflected in the index are established and have proven track record.
We recommend index funds in case of long-term financial goals and to clients having medium risk appetite. For high-risk appetite, one can go for mid-cap, small-cap or sectoral funds aiming at higher alpha. The scenario is likely to continue till such time that active fund managers are able to generate high alpha.
—Prakash Praharaj, Founder, MaxSecure Financial Planners