Index Funds - Pains and Gains

Has the time come for Indians to consider index funds considering actively managed funds are lately finding it hard to beat the market. Or should they continue to stick with active funds for better returns?

See below for some Q&A on this topic

There has been a strong perception in western countries that index funds beat actively managed funds over the long run. Do you agree?

Although we cannot generalize the statement that index funds beat actively managed funds over the long run, it is true that index funds tend to be more consistent in their performance over the long run compared to actively managed funds. This is due to the simple fact that index funds are passive in nature and track the broad market index, and hence are very well diversified with lower alpha.

Is this phenomenon catching up in India as well? Why?

Many mutual fund advisors and financial planners believe that Index funds are likely to make their presence felt in the India in the coming years. They believe that Sebi�s recent re-categorisation of mutual fund schemes might pave for it. The growth of index fund launches by various fund houses are reflective of the growing investor interest in index funds.

With active fund managers are finding it increasingly difficult to beat the benchmarks, is it time for investors to switch to index funds? Or should they continue to stick with active funds for better returns?

Since the investment universe is now clearly defined, actively-managed mutual fund schemes might struggle to beat the broader index. The trend was already visible among large cap schemes where many of them failed to beat their broader benchmark last year. Fund managers explained that was due to rally in only a select few stocks. The fact that passive funds have lower costs involved � how much of a role does this play when it comes to performance vs active funds? Management costs of Mutual Funds have a major role to play in the overall performance returns of the funds. When one looks at the Total Expense Ratio (TER) of any Mutual Fund, combined with various other costs such as Entry/Exit Loads, Transaction charges and management fees, the difference between an active and a passive fund can be significant. Those investors who wants to invest in the broader market and wants more diversification and lower costs can look at index funds as an option. If not a complete switch to passive funds, should investors explore the option of including them as part of their diversification process? How can they find the right mix? A proper asset allocation is very important and a complex question, which depends on various factors such as the investors age, income, savings, existing and future liabilities, investment goal, etc. Once an investor has decided on his allocation to equity, passively managed index funds can give low risk low cost option when compared to actively managed funds or direct equity. One needs to find the right mix by considering the above factors and his/her risk appetite, and by consulting a financial planner. Anything else to add? It is important to note that Index funds are still equity and carry the same risk as the broader equity markets. It is best suited for those who don�t want to take the risk of how a fund manager performs, however are still keen to take some exposure to the equity markets.