FundsIndia.com‘s financial advisory service is much sought after across investors in India and abroad for three important reasons – unbiased solutions to investor queries, a personalized approach with every individual investor, and most importantly, the precedence of expert-backed research over all answers and suggestions.
Yesterday, we received a very pertinent enquiry from one of our investors. We have shared this query and the answer given by our Head of Mutual Fund Research, Vidya Bala, as we believe it will benefit many investors who wish to make the most of their mutual fund investments. Please find the Q&A below:
I am thinking of investing in index funds (for example, HDFC Index – Sensex Plan). Over a period of time, I intend to completely move my assets currently in other mutual funds to one index fund. The reason behind this is that the past performance of index funds are comparable to good performing regular mutual funds, besides being comparatively cheaper. Index funds are extremely popular in US and many, including Benjamin Graham and Warren Buffet (in the book – The Intelligent Investor), advise passive investors to chose SIPs in index funds.
However, in India, I have not seen many articles/studies that show the performance of index funds vis-a-vis regular mutual funds (say a diversified fund). Your comments on my query will be extremely useful to make a judicious decision for me.
Thank you for writing to us. The reasons that make index funds popular in the US may not entirely hold good in India for the following reasons:
One, the Indian markets lack depth and are not as evolved as the US markets. Hence, there are plenty of opportunities outside of the index that an actively managed fund can tap, as the index does not capture the broad market too well.
Two, the tracking error (and therefore, expenses) in the Indian context is higher as a result of poorly constructed indices and the difficulty involved in tracking them.
Three, the choice of indices is mostly restricted to Nifty and Sensex here. We do not have the variety of indices that US offers.
Four, index funds work well if markets are efficient. Since all information that may affect a stock’s price is already factored in its price, you have very little scope to gain beyond that. However, in the Indian context, there is a larger group of stocks, especially in the mid and small-cap segment that see constant re-rating and price discoveries as information is not free flowing.
Five, the index stocks picked here have liquidity as a major consideration and therefore, some very fundamentally sound companies may be left out of the index for this reason.
The proof of this is reflected by way of performance of index funds in India when compared with actively managed funds. Over a 5-year period for instance, more than 2/3rds of diversified equity funds with a 5-year record comfortably beat the average return of index funds (19.5% compounded annually).
This does not mean that you should not go for index funds. A good index fund may form part of your core portfolio, along with a few active equity funds with a consistent record (than a flashy one) built around that, based on your requirement and risk appetite.
We have a call on HDFC Index-Sensex Plus Plan (not the same as Sensex Plan). You may view it by clicking here.