Invest in index funds for a diverse portfolio
Investing in index funds helps in achieving diversification with no additional cost or time spent on research.
K Vijayan, MD and CEO, IDBI Asset Management
With India's stock market becoming one of the leading global markets, it will be increasingly difficult for active funds to provide current levels of returns with current costs. Therefore, index funds are going to become increasingly attractive for their low costs. Coupled with the fact that manpower movement is a fact of functioning in the industry, the case for index funds is quite compelling to investors.
Markets are becoming confident and are stabilising and the Indian investor is definitely realising the potential and value of index funds. As such, the focus of mutual funds is going to be on simplicity coupled with efficient delivery and cost. It certainly appears, considering all these factors, that the era of index funds is here to stay in India.
Our stock market volumes is the fourth largest in the world. However, there may be liquidity issues in a number of stocks, which is where active funds may falter. Active managers take risks in booming markets that often comes to haunt them in bear markets, as recent market volatility has illustrated. When active funds invest outside the index, they take on stock and sector risk.
This move may result in churn, illiquidity and volatility of the portfolio. Passively managed (index) funds do not depend upon the individual decision on and preference of stocks by a fund manager. Hence, index funds are independent of the competence of an individual fund manager, his longevity, his consistency and his character.
The greatest advantage of an index fund is that you have to worry less about such events as the index committee or agency-whose members may change but whose processes are independent-takes care of such developments on an on-going basis. They do not take the decision based on 'hot tips' or broker influence and are not affected by the departure of a fund manager.
This is a major why, as markets become more efficient, most long-term investors prefer to invest in index funds rather than actively-managed ones. A Systematic Investment Plan (SIP) taken in a top performing fund in a booming market can also be a casualty of volatile times. In an index fund, which moves in tandem with the index, the NAV will not face volatility other than that of the stock market.
Comparatively, an SIP in an active fund in volatile times depends upon the stocks selected by the fund manager. Hence, it would be most prudent for risk-averse investors to choose a plan in an index fund.
However, investor awareness in India is still extremely low. Actively managed funds are the most advertised and discussed funds in the country. This means index funds are rarely considered by investors and the benefits these funds rarely reach investors. Further, due to the lower cost structure, it becomes difficult to provide competitive intermediation for these funds.
The point of investing in index funds is that it helps in achieving diversification with no additional cost or time spent. The investor saves on the time and money required to research and analyse stocks for diversifying a portfolio. Hence no strategy is required of either an investor or a manager, reducing the risk of erroneous decisions.
K VIJAYAN
MD and CEO, IDBI Asset Management
