Time for passive investing in India is coming…

I have always wondered this aspect of mutual funds in India. If Indian equity markets have indeed become more efficient over the years, why is it that active mutual funds continue to do better than passive funds? Why are active funds preferred over passive funds? After all if markets are getting efficient, then information asymmetry is becoming lesser. The fund managers should be knowing as much as entire markets and no advantage can be drawn from any analysis.

Dhirendra Kumar of Valuresearch feels time for passive funds is coming in India:

So should you invest in index funds? So far, the answer has been no. However, I can see symptoms that tell us the time for passive investing is well on its way. So far, index investing has not succeeded because the market was not heavily institutionalised and large chunks of companies were not owned by professional fund management. This is now changing.

Another huge factor which points towards the impending rise of passive investing–the main one, I feel–is rising costs. Fund management costs have now gone through the roof. Actively managed funds charge up to three per cent of total assets. This is something that will now start impacting returns in a way that is noticeable to investors.

The next factor is the size of the funds. Indian equity funds have been seasonal and small. A small fund can opportunistically try many investments in midcap and smallcap companies that can yield returns that have a big impact on the portfolio. This is not possible for large funds. The Indian equity fund universe is now dominated by big funds. There are now more than fifteen funds that have more than Rs 10,000 crores. Seven-eight funds are close to Rs 20,000 crore. Such funds have no choice but to be large cap funds. They’re finding it hard to beat the index consistently. They have a compelling performance track record over a long period and they have beaten the indices by a big margin. However I visualise that going forward, because of their size, because of the expenses they charge, and because of the growing institutionalisation of the market, they won’t find it easy to outperform.

So does that mean that if you are starting an SIP for ten years, you should do so in an index fund? Well, the case is not that strong yet. Over the last five years, the top five actively managed funds would have earned you one and a half times more than a Nifty fund and that’s a big difference.

However, it’s something that an investor should keep a watch on. At some point in the coming five years, there will likely be a time when it will make sense to stop your SIP in an actively managed fund and turn to an index fund. We’re heading in that direction, slowly but surely.


Will be interesting to watch this space. Another interesting aticle says we need more broad based indices before passive funds can kickoff in India..


2 Responses to “Time for passive investing in India is coming…”

  1. Lestat de Re Says:

    ‘index investing has not succeeded because the market was not heavily institutionalised and large chunks of companies were not owned by professional fund management’ How or why is this a factor in the non performance of index funds?
    fund size growth happens incrementally, sometimes at a faster pace but still incrementally… which inherently implies that even the performance of index funds should improve (as their allocation to companies improves etc… drawing from the argument made)… However while assuming the markets are getting more efficient, you seem to buy Mr. Kumar’s argument which if true highlights a major inefficiency in the market associated with asset allocation. Funds are allocated to investments either based on only backward looking performance (usually adopted by a majority of semi professional and non professional investors) and forward looking projections, used by professional investors, turnaround investment specialists.
    The markets are inefficient, so are funds, the larger they get the more inefficient they are, which is why even Berkshire is not a mutual fund, they operate like an active investor.
    Index funds, SIPs and mutual funds are fundamentally flawed. When ever you apply a ‘one size fits all’ philosophy to anything in life it is doomed to fail. But I welcome such initiatives, your thesis is incorrect even if what you are saying is true, the opportunity for the individual active investor will always be the most lucrative because his size is small and he does not have to be committed to losers that large mutual funds end up attributing some funds to because they just have too much to deploy! Snake oil sales men will always sell snake oil, dont expect something else.

  2. Linkfest - Kairos Capital Says:

    […] Mostly Economics – Dhirendra Kumar: Time for passive investing is coming […]

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