Index funds’ outperformance over large-cap peers boosts their appeal

Wealth managers are increasingly asking investors to allocate some portion of their portfolio to passively-managed index funds instead of large-cap funds with several actively-managed large-cap equity mutual fund schemes underperforming their benchmarks in last one year.

An actively-managed equity scheme is one in which the fund manager takes decisions about how to invest the fund’s money. A passively-managed fund, by contrast, simply follows a market index, like the Sensex or Nifty. Its fund manager does not take any active investment decision.

Over the last one year, index funds have outperformed actively-managed fund categories. Actively-managed large-cap funds have lost 0.37 per cent, while the index funds mimicking the Nifty have gained 3.87 per cent, as per data from Morningstar India.

Financial planners point out that after Sebi norm on categorisation and rationalisation of mutual fund schemes, large-cap stocks are mandated to hold 80 per cent of their portfolio in top 100 stocks by market capitalisation, making it difficult for them to generate alpha, prompting investors to look at passive funds.

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Earlier many such large-cap funds took exposure to mid- and small-cap stocks and generated alpha.

“We recommend index funds as an alternative to large-cap funds. Post categorisation, it is becoming difficult for large-cap funds to generate alpha. Added to that index funds score due to their lower expense ratio,” says Jitendra Solanki, founder of JS Financial Advisors.

Typically most actively-managed equity mutual funds charge expense ratio in the range of 1.5-2.5 per cent, while passively-managed equity funds could charge anywhere between 0.05 per cent and 1 per cent.

Wealth managers say given their simplicity and low cost, index funds are a good starting point for first time investors, especially those moving to equities from fixed deposits.

In the last one year, Nifty returns have been concentrated and have come from a handful of stocks. Stocks like Bajaj Finance, Tech Mahindra, Axis Bank, Hindustan Unilever and Reliance accounted for a bulk of the Nifty returns and hence actively-managed large-cap funds lost out.

“Index funds are easy to understand and relate to. In a country where there are only two crore mutual fund investors, they (index funds) will help increase penetration and get investors into the country,” says Anil Ghelani, senior vice-president, DSP Mutual Fund.

Fund houses have increased their product offering in the passive space over the last couple of years. Recently, DSP Mutual Fund launched DSP Nifty 50 Index Fund and DSP Nifty Next 50 Index Fund. Aditya Birla fund house has launched a Nifty Next 50 ETF. SBI MF has launched a smart-beta ETF, a hybrid between traditional passive and active strategies.


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