The battle between actively managed and index funds is now 50 years in the making. Are Index funds better than actively managed funds?
In this video, ETMONEY’s Shankar Nath dives into this debate of active versus passive investing with some history, data, analysis, and a little bit of opinion.
Topics Covered in the video:
00:00 INTRODUCTION
00:48 HISTORY OF INDEX FUNDS
04:12 WHAT ARE INDEX FUNDS?
08:35 ACTIVELY MANAGED MUTUAL FUNDS VS PASSIVELY MANAGED INDEX FUNDS
15:20 ETMONEY OPINION
Resources:
Asset allocation Video - https://youtu.be/MYZO5D7puTA
Should you chase top-performing funds - https://youtu.be/EEJ1Nj2de8U
ETMONEY Blog - https://www.etmoney.com/blog
👉 WHAT ARE INDEX FUNDS?
An index represents the value of a particular group of investments.
Eg: The Sensex is an index that tracks the performance of 30 of the largest and most actively traded stocks on the Bombay Stock Exchange.
Likewise, the Nifty50 Index represents the weighted average of 50 such companies on the National Stock Exchange
An index is nothing but a generic term that describes a list of securities that are selected and weighted according to a set of rules
An index fund is simply a fund that tracks a market index. In other words, the index fund simply buys up all the shares that make up a particular index per the weightages and methodology prescribed. The index fund owns all the shares that make up the market one would end up earning the average returns of all stocks in that market
Advantages
Index funds offer a much broader diversification than what any actively managed mutual fund can offer
Minimum Fund management expenses
The index fund achieves this by ---
a) not having to pay any advisory fees or salary to a research team ..
b) by savings on account of low portfolio turnover which reduces trading fees and taxes
Index funds serve as one of the finest vehicles that support asset allocation.
👉 ACTIVELY MANAGED MUTUAL FUNDS VS PASSIVELY MANAGED INDEX FUNDS
Ever since index funds were introduced in the 1970s, there has been a battle going on between actively managed funds and passively managed index funds.
In this section, we examined this tussle from three perspectives -
The moral justification
The performance angle
The risk explanation
👉 The Moral Justification
- actively managed funds are of the opinion that markets are often mispriced and the fund manager is in the best position to exploit this opportunity and make a lot of money for the investor
- The index manager’s view is that the current price at which any stock is quoted has already been taken into all known and available information.In other words, this is the price that has been agreed to by a willing buyer and willing seller in the open market and hence it is impossible to capture excess returns without taking additional risk
👉 The performance angle
We looked at all available actively managed large-cap funds and all available large-cap index funds to draw a comparison.
In a universe of 44 large-cap funds, there were 29 actively managed funds and 13 large-cap index funds. In the more recent years, especially since 2018 onwards we see that the index funds have performed a bit better than the average mutual fund. There is not much difference in performance between an average actively managed mutual fund and an index fund
We looked at how many of the many active funds have underperformed when compared to the typical Nifty 50 index fund.
If we give more weightage to the recent years i.e. 2018 onwards, we see that half or slightly more than 50% of the actively managed large-cap funds have struggled to keep up with a Nifty 50 index fund. The average the last 4 years of data, we see that 61% of the active funds unperformed.
The global data on active vs passive funds shows that a win-loss ratio of about 1:2 .. i.e. about 66% of actively managed funds underperforms the index funds.
In India, this ratio seems to be more of 1:1 if we take the last three years of data .. but it does come very close to the 1:2 ratio if we take the last four years of data.
👉 The risk angle.
From a risk perspective if not tracked, investing in actively managed funds can create high uncompensated risk in a portfolio.
👉 ETMONEY OPINION
This battle between actively managed and index funds is now 50 years in the making and if data were to be believed index funds seem to be winning.
Globally index funds have captured a larger share of the wallet as compared to active funds .. and there is a growing case for that happening in India too over the next decade
#ETMONEY #indexfunds #MutualFunds #Activelymanagedfunds
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