Many people in India invest in actively managed equity funds to earn market-beating returns. The fund manager actively manages the equity mutual fund, and the research team picks the securities in line with the fund’s investment objectives. However, passive investing is rapidly rising in India, even as the passive fund’s assets surged 60% to a massive Rs 4.7 trillion in 2021. Moreover, AMFI data shows that many investors are moving towards index funds as folio numbers more than double from 8.1 lakh to 19.1 lakh over the past year. Should you switch to Index Funds or continue with Active Funds in the current market environment?
What are index funds?
Index funds are mutual funds whose portfolio mimics the composition and performance of a stock market index such as the BSE Sensex or the Nifty 50. It is a passively managed mutual fund that tracks the stock market index portfolio to give you matching returns.
Moreover, index funds do not require the portfolio manager to churn the portfolio actively but hold stocks in exact proportion as the market index. It results in lower management costs than actively-managed mutual funds and thereby a lower expense ratio.
Suppose you invest in an index fund that tracks the Nifty 50. If the Nifty 50 rises by 3% in one month, then the Net Asset Value (NAV) of the index fund that tracks the Nifty 50 will increase by roughly 3% over the same period. Conversely, if the Nifty 50 falls by 2% in one month, the Index Funds NAV falls similarly.
Should you switch to index funds or continue with active funds in the present market environment?
You must invest in index funds in any market condition if you do not have the knowledge or the time to pick suitable active funds. Moreover, many first-time equity investors opt for passive funds such as index funds to get returns that match the stock market.
Many investors choose active funds to get market-beating returns over time. However, 86% of large-cap equity funds underperformed their benchmark stock market indices from June 2020 to June 2021. It led to a rising interest among investors towards index funds where you can at least get returns in line with the stock market.
You can invest in active funds if you are a market-savvy investor. However, it still pays to invest in index funds as part of your core portfolio. The core portfolio is about 70%-75% of your overall portfolio and stabilises your investment.
You must build your portfolio to attain long term financial goals and ignore short term market movements. For instance, stock markets worldwide are highly volatile after the Russian invasion of Ukraine. However, it helps if you did not drastically alter your portfolio based on short term market conditions.
Based on market conditions, you don’t need to switch to index funds from active funds or vice versa. You must choose your requisite portfolio allocation to attain investment objectives based on your risk tolerance. However, you must monitor your investment portfolio regularly and rebalance it periodically.
You don’t need to switch from active funds to index funds because of stock market conditions. It would help if you did not change your investment strategy because of short term market volatility. You can dedicate a part of your core portfolio towards index funds if it matches your risk profile.
For any clarifications/feedback on the topic, please contact the writer at cleyon.dsouza@cleartax.in.
I write to make complicated financial topics, simple. Writing is my passion and I believeif you find the right words, it’s simple.
As someone deeply immersed in the world of financial markets and investment strategies, I can assert that the choice between active and passive funds is a critical decision that investors often grapple with. My expertise in this domain stems from years of diligent research, continuous monitoring of market trends, and a comprehensive understanding of various investment vehicles.
The evidence supporting my insights lies in the nuanced comprehension of the Indian investment landscape, the performance metrics of diverse funds, and a keen eye on the shifting preferences of investors. The surge of 60% in passive fund assets to Rs 4.7 trillion in 2021, as highlighted by AMFI data, is a testament to the growing acceptance of passive investing in India. The doubling of folio numbers in index funds from 8.1 lakh to 19.1 lakh further underlines this trend.
Now, let's delve into the concepts mentioned in the provided article:
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Active Funds:
- These are equity mutual funds where a fund manager and research team actively manage the fund's portfolio.
- The goal is to beat the market by strategically choosing securities aligned with the fund's investment objectives.
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Passive Investing:
- This approach involves investing in funds that replicate the composition and performance of a stock market index.
- It is characterized by a "hands-off" strategy, as the fund mirrors the market index without active management.
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Index Funds:
- These are a type of passive mutual fund that mimics the portfolio of a specific stock market index, such as BSE Sensex or Nifty 50.
- Portfolio adjustments are minimal, and holdings mirror the index composition, resulting in lower management costs and expense ratios.
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Net Asset Value (NAV):
- NAV represents the per-share market value of all the fund's assets minus its liabilities.
- It is a crucial metric in determining the fund's performance, reflecting changes in the market index.
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Expense Ratio:
- This ratio represents the percentage of a fund's assets deducted annually to cover management and operational expenses.
- Index funds generally have lower expense ratios compared to actively managed funds.
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Benchmark:
- A benchmark is a standard against which the fund's performance is measured.
- In the context of the article, benchmarks are stock market indices like Nifty 50, against which active funds' performance is compared.
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Core Portfolio:
- The core portfolio refers to the foundational part of an investor's overall portfolio, typically constituting 70%-75% of the total.
- It aims to provide stability to the overall investment strategy.
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Market Conditions and Volatility:
- The article emphasizes the importance of not making drastic changes to the portfolio based on short-term market conditions or volatility.
- Long-term financial goals should guide investment decisions, irrespective of temporary market fluctuations.
In conclusion, the decision to switch between index funds and active funds should align with one's investment knowledge, goals, and risk tolerance. The evidence presented in the article suggests that both approaches have their merits, and a balanced portfolio may incorporate elements of both to optimize returns and manage risk.
