If you canít beat the index, invest in it - Views on News from Equitymaster

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If you canít beat the index, invest in it

Aug 29, 2001

Increasingly Ďactiveí fund managers are finding it difficult to outperform the benchmark indices. So what does the investor do? Simple. When you canít beat them, you join them.When active fund management does not yield the desired results, trust index funds to deliver. As a matter of fact, index funds always deliver.

It seems even fund houses seem to have realised that, which could explain the string of index funds on the anvil. Newspaper reports reveal that quite a few fund houses have filed their index fund prospectuses with the SEBI and Pioneer ITI has already launched its index offering.

  • Invest online in Pioneer ITI Index Fund.

    But what are index funds and how are they different from other funds? An index fund simply replicates a popular benchmark index like the BSE Sensex or the S&P CNX Nifty. The fund invests in the same companies as the index and in the same proportion. This is also known as passive investing as opposed to active investing where the fund manager has leeway to invest in any company and in any proportion within the broad guidelines of the market regulator. As is evident, the index fund will never outperform the index nor does it attempt to, rather it only tries to mirror the performance of the index.

    If index funds are only going to mirror the index why should anyone invest in them? Index funds are ideal for the investor who wishes to take exposure to the equities market but does not have the expertise or the time to track them. For a first time investor, an index fund can be very comforting as he is not unduly worried about seeing his investment eroding vis-ŗ-vis the benchmark index as he is invested in the index itself. In these volatile times, even seasoned investors can invest in an index fund as fund managers are and will continue to find it difficult to beat the index.

    There is another front on which index funds outperform actively managed funds and that is fund management cost. Index funds being passively managed do not incur fund management costs vis-ŗ-vis actively managed funds that incur equity research and fund managerís fees, which can be significant. Over the last 12 months, fund managers have some explaining to do about why they should be paid their exorbitant fees, which is not backed by performance. As the net asset value (NAV) takes a hit when costs/expenses escalate, in terms of cost efficiency index funds are far superior to their more Ďactiveí peers.

    In the domestic market, index funds have yet to take off in a big way. But in developed markets like the US, index funds have been staple diet for the mutual fund investor.

    In an interview to personalfn.com, Mr Sanjay Sachdev (CEO and MD of IDBI-PRINCIPAL Asset Management Company), who has worked in the US himself had this to say about index funds, ĎI think on the equity side its important to invest in a product like an index fund. When the market is down and the index is languishing, its a no-brainer frankly. Index funds have the lowest expense ratio in the country and you are not relying on an active fund manager to invest for you. In the US mutual fund industry, Vanguard is ahead of even Fidelity largely due to their index products. An index fund is one of the best long-term investments. We know that the market (BSE Sensex) is at 3,200 points and it is going to go back to 4,000 points, all we donít know is when and an index fund makes sense from that perspective.

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