Index funds in India is a fairly new concept. It is extremely popular in the United States but not very appealing in India. Moreover, it has its own advantages for developed economies. Furthermore, index construction due to a handful of big companies produces great returns in the case of emerging economies. Consequently, it helps to beat the index in the long term. We discuss everything about index funds in this article. Read on!
Index funds in India are a fairly new concept. It is extremely popular in the United States but not very appealing in India. Moreover, it has its own advantages for developed economies. Furthermore, index construction due to a handful of big companies produces great returns in the case of emerging economies. Consequently, it helps to beat the index in the long term.
What are Index Funds?
Index funds thus invest in broad market indices like Nifty, Sensex, etc. Moreover, all the stocks in these indices will be present in the portfolio. Thus, this ensures that the portfolio copies the performance of the index it follows. Also, the expense ratio is low as it is passively managed. These funds seek to just perform parallel to the index they track. Such funds help in balancing the investment risks.
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Do Index Funds make sense in India?
We often receive a lot of queries and comments regarding index funds in India. They are highly popular in US markets while they are quite new to the Indian markets. Moreover, these funds offer low-cost diversification choices in developed economies like the US. In India too, these funds offer low-cost investment options in comparison to an actively managed fund. Also, NiftyBees ETF which tracks the Nifty50 index charges only 0.05% p.a. of the total AUM.
Though these funds have a lot of good things about them, they are not yet attractive for Indian investors. Furthermore, if we separate the EPFO contribution to the fund, these funds form less than 5% of the total AUM.
AUM is the assets under management.
Why is Index Investing not picking up in India yet?
1. Active funds beat the Index
According to the SPIVA (S&P Index versus Active funds) scorecard in the US, active funds have a poor history of beating the index funds.
As you can see in the figure, less than 20% of the US funds in the multi-cap or mid-cap category are thus able to beat the index returns over a 10 year or 15 year period.
In contrast to this, if we look at the Indian markets(excluding the Large-cap funds), the multi-cap and mid-cap/small-cap funds have a good record of beating the index post fees. Records suggest that one in two funds easily beats the index over a 10 year period.
Moreover, a 50% odd of beating the index is worth giving a try for most investors in comparison to 20% in the case of the US markets.
2. Taxation
The index follows a buy and holds strategy. After buying, the index rarely sells stocks that meet the free-float criteria. Thus, the turnover ratio( percentage change in a portfolio over 1 year) of these funds is reduced.
Moreover, US income tax laws state that if a fund buys or sells a stock, the investor in that fund will have to pay a capital gain tax. In case of an actively managed fund, if the turnover ratio is higher it will attract more taxes. Thus, the returns will reduce. While an index with a low turnover ratio will be taxed less.
In contrast, if the investor sells their stocks only then will they be taxed. Thus, index funds have no effect or edge over actively managed funds in India.
3. Accumulation
These funds in India are far less diversified with respect to the sectors. In contrast, the fifth stock in the US markets is less than 2% of the index. Thus, the other stocks also get a good presence.
Also, an index having over 60% portfolio comprising of top 10 stocks has two problems: i) they are highly risky and the future performance will depend on these top 10 stocks ii) there are many other stocks that do not find any representation in the portfolio and give higher returns. Thus, an active fund manager can get superior returns by picking specific stocks.
Our Opinion
1. Stock market investing is a zero-sum game. Thus, where one person gains and the other loses. The returns in this fund will be the average returns that all investors get. When you will sell Kotak Mahindra Bank stock, some other person will buy it. So if the bank's price goes up, you will lose the gains. Thus, it is common for one set of investors to gain and others to lag.
2. Moreover, given the benefits of active investing, we strongly recommend the Indian investors build a systematic process-oriented portfolio with the help of competent advisors for a very nominal fee.
3. Investify Wealth Advisors Pvt Ltd. portfolio, which strongly pursues Quality at an affordable price with the right blend of investment principles, has been successfully managing index funds for many years.
4. Investify Wealth Advisors Pvt Ltd. also recommends actively managed mutual funds which follow special principles of Value, Quality, and Size. These principles can suitably beat index fund returns over the long term. Moreover, it is well established by research.
5. It must be understood that to perform better than the index fund, a portfolio must be designed differently than the index. Moreover, it can cause a lead and lag for the short term. Not all investors have the patience and awareness to sustain through the under-performing period. Having a good advisor can save you time and you can thus avoid losses by following their research.
Conclusion
Index funds are mutual funds that invest in an index like the Sensex or Nifty. Moreover, all the stocks in these indices are present in these funds. Thus, the performance of the index is copied by these funds. These funds are highly popular in developed markets like the US, where actively managed funds rarely beat the index.
However, in the case of India, these are not so popular yet. Furthermore, to profit from actively managed funds, an investor needs a sound advisor who would help them gain from their expertise. Investify Wealth Advisors Pvt Ltd offers the finest advisory and can help you achieve your investment goals at an affordable price. Happy investing!
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