What Are the Reasons for the Growing Popularity of Index Funds? - Outside View by PersonalFN

Helping You Build Wealth With Honest Research
Since 1996. Try Now

  • MyStocks

MEMBER'S LOGINX

     
Login Failure
   
     
   
     
 
 
 
(Please do not use this option on a public machine)
 
     
 
 
 
  Sign Up | Forgot Password?  

What Are the Reasons for the Growing Popularity of Index Funds?
Jan 8, 2019


Popular campaigns like Mutual Funds Sahi Hai. and initiatives by many other mutual fund houses have helped attract more investors towards mutual funds in the last couple of years.

Historically, mutual fund investors have been more influenced by the market-beating returns generated by actively managed funds. But recently, there has been a paradigm shift in the way they perceive mutual funds.

Passively managed index funds and ETFs (that was kind of completely ignored category of funds by retail investors in India) have slowly started gaining momentum. Notably, the concept of index funds is quite popular in developed markets like the U.S.

Seeing the underperformance of the actively managed funds against the key benchmark indices like S&P BSE Sensex and Nifty 50 index in the last one year, many investors now want to get the taste of passively managed funds. It is noteworthy that passively managed funds tracking the popular index have managed to outperform their active peers by a noticeable margin.

All thanks to index heavyweights like Reliance Industries that have been driving the rally in larger indices.

Due to the increasing popularity in this space, mutual fund houses have launched index-based funds, vying for a piece of the pie.

  • Mirae Asset Nifty 50 ETF
  • Tata Nifty ETF
  • Aditya Birla Sun Life Nifty Next 50 ETF
  • ICICI Pru Nifty Next 50 ETF
  • SBI-ETF Sensex Next 50
  • ICICI Pru S&P BSE 500 ETF
  • SBI Quality ETF
--- Advertisement ---
13 'Must-Own' Stocks for 2019

Radhika and Sarvajeet, co-editors of Smart Money Secrets track over 40 of India's most successful investors, bringing the best of their stock picks to their subscribers…

And they've identified 13 potentially profitable stocks that you could consider adding to your portfolio right now!

Click here for full details on Sarvajeet and Radhika's stock picking strategy – and to get access to these 13 stocks.
------------------------------

For those who don't know what Index funds are...

Index funds are a category of Mutual funds that try to imitate the portfolio of a market index (say Nifty 50 or S&P BSE Sensex) by investing in stocks that are a part of the Index in the same proportion as in the index. These funds are passively managed and simply try to replicate the performance of the underlying benchmark.

Currently, index funds are coming into the limelight for the following reasons.

  1. Short-Term underperformance by Actively managed funds

    In February this year, the regulator mandated mutual fund houses to compare the returns of their scheme to Total Return Index (TRI) Benchmark. The shift from vanilla index returns to TRI gave a clear picture of the schemes' performance versus its benchmark. This also enabled the investors to see that the alpha generated by the actively managed funds is disappointing. The number of actively managed funds outperforming the benchmark has come down and has even raised doubts in the minds of investors about the potential of actively managed funds.

    Followed by the short-term underperformance of actively managed funds, many investors doubt the human abilities to choose good companies on a consistent basis. In short, they are apprehensive about active portfolio management. Although they still recognise and acknowledge the importance of equity as an asset class and believe in the return potential of equity assets, there has been some shift in focus towards passively managed funds that mimic an index. It will be interesting to see how long this trend of underperformance by active fund managers will continue.

  2. Lower expense ratio

    The expenses charged by actively managed funds are much higher as compared to passively managed funds. While the expense ratio of actively managed funds varies within the range of 1.5%-2.5%, the passively managed index funds and ETFs typically have an expense ratio of about 0.25%-0.50%. Passively managed funds turn out to be more economical for investors and also boost the net returns the fund generates for its performance. Clearly, investors do not prefer paying someone a higher fee for poor performance.

Are investors right in switching to Index funds, now?

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 still offers lots of opportunity 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. In our understanding, we are far away from having a complete passively managed fund industry. Do not forget, a large number of investors continue to prefer market-beating returns over market linked returns.

[Read: Should You Be Investing In Passive Funds Now?]

If you wish to get the taste of passive investing, make sure you do not go overboard on index funds. Maintain a fair allocation between actively and passively managed funds. An allocation of 80:20 could be fair if you still aim to beat the markets.

Editor's note:

Here is a strategy that has the potential to beat the markets in the next 7-8 years. Our 'Strategic Funds Portfolio for 2025' is backed by the 'core and satellite' approach of investing that many successful investors have adopted for long-term wealth creation.

If you're an investor looking for "decent investment gains at relatively moderate risk" PersonalFN's Premium Report, "The Strategic Funds Portfolio For 2025" could be a ready solution for you.

This report contains a ready-made portfolio of some of the best equity funds picked by our research team for the year 2025 that have the potential to generate lucrative returns over the long term. Click here to know more.

Author: Aditi Murkute

This article first appeared on PersonalFN here.

PersonalFN is a Mumbai based personal finance firm offering Financial Planning and Mutual Fund Research services.

Disclaimer:

The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.

Equitymaster requests your view! Post a comment on "What Are the Reasons for the Growing Popularity of Index Funds?". Click here!

  

More Views on News

My Latest Stock Recommendation (Fast Profits Daily)

Oct 9, 2020

How I picked an exciting stock using trends from both the commodity and equity markets.

Data is the New Oil but It's Also the New Sugar. Here's How to Fight it (Profit Hunter)

Jun 1, 2020

Is too much data hurting your quest for market beating returns?

Quantum Mutual Fund: Hum woh nahi hain (The Honest Truth)

Apr 29, 2020

Ajit Dayal on how the mutual fund industry robs you of your wealth.

This One Trigger Could Turnaround Yes Bank's Stock Price (The 5 Minute Wrapup)

Oct 16, 2019

If Yes Bank manages to do this, it could be the start of a much-needed turnaround for the bank.

Gold could Hit 40,000 Sooner Than Expected (Profit Hunter)

Aug 16, 2019

Domestic gold prices are firing on both engines now. Gold prices could touch 40,000 faster than you could imagine.

More Views on News

Most Popular

It's the Beginning of a New Bull Phase in Smallcaps (Profit Hunter)

Feb 24, 2021

Last time the smallcap index crossed 19k a big correction followed. Here's what makes it different this time.

Make Rs 5,000 Per Day Trading the Market (Fast Profits Daily)

Feb 25, 2021

In this video, I'll show you how to get started on the path to daily trading profits.

The Hidden Tesla in My Great Indian Wealth Project (Profit Hunter)

Feb 23, 2021

An Indian company founded three decades ago in a garage caught my attention...

How Much Money For Day Trading? (Fast Profits Daily)

Feb 22, 2021

In this video, I'll show you how to allocate your capital as a day trader.

More

India's #1 Trader
Reveals His Secrets

Secret To Increasing Your Trading Profits Today
Get this Special Report,
The Secret to Increasing Your Trading Profits Today, Now!
We will never sell or rent your email id.
Please read our Terms

MARKET STATS