A Case for Boredom in Investing – Active Funds vs. Passive Funds
And an Introduction to Index Investing.
The V-shaped recovery in the Indian Stock Market post the bloodbath in March 2020 has resulted in the precipitation of the fact that there is a massive influx of new market participants. The new-age retailers are more active and aware. However, there’s a need for a nudge. The period of abnormally high returns is behind us. Not every stock one picks will double/triple their money, and it might feel like the magic wand is just not working anymore. In the long term, returns always return to the mean and thereabouts, driving home a bitter fact that stock picking is not as easy as it seemed 6-8 months ago. And with it, probably, a realization that investing requires a lot of research, time and a certain temperament in terms of behaviour/psychology.
Folks. This is where the Mutual Funds Sahi Hai advertisement comes in. Mutual Funds can either be actively or passively managed. Actively managed funds are run by investment managers who are in pursuit to outperform the benchmark index, such as S&P BSE Sensex or NSE Nifty50. Whereas, Passive Funds only exist to track the benchmark index returns. Index Funds, ETFs etc. come under the umbrella of Passive Investing.
We, at Zen Nivesh, are huge proponents of having a Passive fund such as an Index Fund in a long term portfolio. Especially for retirement goals. More on that in the next post. Now naturally, you might be thinking, why would you recommend a fund that would only provide Index returns at best when smart people are paid to beat those returns? Unfortunately, below are the damning statistics proving that not many fund managers manage to beat the Index! Close to 82% of the Equity Large Cap Funds failed to beat their respective benchmark index over the 5-years. Moreover, in the 10-year period ending December 2021, 68% of them have underperformed. The table tells a similar story of underperformance by the ELSS(Equity Linked Saving Scheme) and Mid/Small Cap Funds.
Given that the universe of Large Cap stocks is limited, mutual fund managers find it difficult to generate any alpha in the large-cap fund space. As per the norms, 80% of a Large Cap fund portfolio has to be in the top 100 companies by market capitalization. This signifies that there is little room for the fund managers of large-cap equity funds to beat the benchmark index.
I think I’ve used the word ‘Index’ so many times now that it deserves some light to be thrown at it. An Index in the context of the financial market (securities market) is a rule-based portfolio of stocks. The stocks are represented in the Index based on their market capitalization, a sector they belong to, themes etc. Investing in an Index Fund means that you’re putting money in a particular index, i.e. equity portfolio which is aligned to a specific Index and holds the same stocks with the same weightage as represented in the Index. Here’s a typical illustration of a Nifty50 Index and its constituents:
Sure. Index Funds are not so exciting. But they do make up for this boredom with their long term productivity. We shall dive into the world of Index Funds in our next post. Until next time.