An increasing number of mutual fund houses are seeking SEBI’s nod for their passively managed NFOs. Smaller provident funds have been keen to invest in equity through passively managed funds, on the lines of EPFO, and mutual fund houses are making this an excuse to push more passively managed offerings now.
But there’re more reasons to come up with passively managed or index funds at this juncture.
The underperformance of actively managed funds is haunting almost all fund houses. As the market breadth has been weak, their funds have underperformed Nifty and Sensex. According to Business Standard, 62% of actively managed equity funds have underperformed their respective benchmarks in FY 2018-19.
You would be surprised to know that over 700 companies listed on BSE have a market capitalisation of less than Rs 1,000 crore.
Approximately 100 companies out of BSE 500 companies hovered at their 52-week low in June.
Market cap of “B” group companies is near their 5-year low.
But leading indices such as BSE Sensex and CNX Nifty have managed to touch their all-time high recently.
This disconnect within the market has affected fund manager’s confidence negatively.
Are index funds the way forward?
Index funds are popular in developed countries like the U.S. It is noteworthy that the U.S. is a saturated economy, where the active-fund managers find it difficult to generate alpha over the benchmark. However, India is still a growing economy, which continues to offer lot of opportunities to active-fund managers.
Notably, the size of the mutual fund industry in the U.S. is about 80% of its GDP, while the Indian mutual fund industry is just about 12% of the GDP. So, there is a long way to go before we get to a level where the active fund management becomes completely ineffective and redundant.
Developing countries like India are unlikely to run out of alpha-opportunities any time soon. Simply going by the dominant share of the unorganised sector in the Indian industry, there will be enough alpha-opportunities when these businesses join the mainstream. That said, the recent failure of actively managed funds to outperform broader indices is bound to haunt the industry for some more time.
Here’s why actively managed funds should form the core of your portfolio in 2019 and beyond
- Historically, the top-quartile actively managed funds in India have managed to beat their respective benchmarks consistently and especially in difficult market phases. 2019 is expected to be a highly volatile year for global markets. Apart from facing global headwinds, markets in India will have to deal with lower growth phase and rising unemployment challenges in 2019. If only select companies continue to drive the index, passively managed funds might underperform actively managed funds. But how long is the question. Shrewd fund managers tend to underperform only occasionally.
- Relatively higher costs associated with actively managed funds are often construed as a disadvantage in comparison with passively managed funds. However, expense ratios are likely to drop lower in India as investing in Systematic Investment Plans (SIPs) through direct plans is getting popular. Direct plans can help you save costs associated with mutual fund investing.
- If you want to generate market-beating returns, there’s no alternative to actively managed funds.
At PersonalFN, we are of the view that index funds can form up to 10% to 20 % of your entire equity portfolio. Just don’t get married to the idea that only index funds are the best to invest in mutual fund universe. If you sensibly invest in the best actively managed mutual fund schemes, your portfolio can outperform the benchmark indices. Of course, this is assuming you want and have the appetite for the upside and downside of a 2-4% return.
To build a solid portfolio of actively managed mutual fund schemes, choose them based on various quantitative and qualitative parameters.
Before you invest in mutual funds, it is necessary to check the following:
- Your/Investor’s risk profile
- Your investment objective
- Your financial goals
- The time horizon you have before goals befall