Finding alpha in the future will be harder than it was in the past as the Indian market gets more efficient over time
At a time when the volatility in the equity market is making it extremely difficult for the fund managers to beat benchmark indices, Pratik Oswal, Head of Passive Funds at Motilal Oswal Asset Management Company recommends that investors look at passive funds.
This is also evident from the latest SPIVA report. The latest S&P Indices Versus Active (SPIVA) India Scorecard reveals that over the one-year period ending June 2019, 80.95 percent of Indian ELSS funds underperformed their benchmarks. The scorecard further indicated that 76.67 percent of the large-cap equity funds underperformed their respective indices.
Also, in the last three to five years, few active funds have managed to deliver consistent performance.
“Passive funds are for investors looking for something simple, cost-effective and long-term effective with regard to returns," said Oswal in an interview with Moneycontrol.
Passive investing is an investment strategy to maximize returns by minimizing buying and selling.
Exchange-Traded Funds (ETFs) are examples of passive products. The units are listed and traded on the stock exchanges like shares. You can buy and sell units at the prevailing market prices on a real-time basis during market hours.
Usually, ETFs are passive funds where the fund manager doesn’t select stocks on your behalf. Instead, the ETF simply copies and tracks an index.
Oswal pointed out that there are lots of debates globally on whether long-term alpha exists or not in active funds.
“My belief is that for alpha to not exist, markets need to be extremely efficient. And I don’t believe India is still there yet in terms of efficiency," Oswal said.
He also feels, finding alpha in the future will be harder than it was in the past as the Indian market gets more efficient over time.
“Today the conversation is moving from fund selection to asset allocation. What passive strategy does is make investors focus on the right mix of funds and not on returns, which have proven to be volatile,” Oswal said.
He believes asset allocation also reduces market timing and portfolio churn both proven to be ineffective. “Passive funds help by removing some elements of unpredictability and also help reduce costs,” Oswal said.
Since active funds try to beat their benchmarks through careful stock selection by a fund manager, the fee charged is higher, while for passive funds that simply mirror the index by investing in the same stocks in the same proportion, with no active management, charges are lower.
Currently, the expense ratio of passive funds is up to 1 percent, while that of active funds is up to 2.25 percent.
He suggests that most portfolios must have a combination of active and passive strategies with at least 10-20 percent allocation in passives, to begin with.
Prior to joining Motilal Oswal in May 2019, Oswal was heading operations and finance at a Series A Fintech start-up (StratiFi Technologies Inc.) in San Francisco.
Apart from fintech, Oswal has experience working in areas such as Investment Banking, PE (private equity) and also in running an options arbitrage desk.
He studied math and economics at Emory University and has an MBA from London Business School.
In 2010, Motilal Oswal AMC started its operations by launching a slew of index funds and exchange-traded funds. Currently, it offers three exchange-traded funds and four Index funds.
Index investing in one common passive investing strategy, whereby investors purchase a representative benchmark, such as the S&P BSE Sensex Index, and hold it for a long time.
When asked if there is scope to reduce the cost of ETFs further to appeal to institutions such as pension funds of PFRDA, Oswal was of the view that in India ETF costs are already very low.
ETF growth, Fund Launches
As of Sep-end, the average assets under management of Motilal Oswal AMC stood at Rs 18,934 crore, of which merely Rs 450 crore, are from ETFs and index funds.
According to Oswal, there is a lot of opportunity in the index fund and ETF space and he believes that mutual fund equity AUM, which is currently at Rs 10 lakh crore, can go up to around Rs 30-35 lakh crore in the next five years.
To tap this long-term potential, the fund house is mulling launching passive products across market caps, largely in the multi-cap, mid-cap, and small-cap segments and is also likely to launch a bank index fund.
“We will be launching the Nifty Next 50 and Nifty 50 funds by the end of November or in the first week of December. Our focus will be on index funds. ETFs, we will see as the market progresses,” Oswal said.
The top-most challenge, which is deterring retail investors from investing in passive funds, is the lack of awareness.
“People don't know what active is and what passive is. There is a need to educate people so that they can select the right fund/asset mix.”
He is of the opinion that gradually awareness is growing but only among young investors in the age of 25-40, who are going for direct investments in the mutual fund space.According to Oswal, the current ecosystem does not help passives to grow, as mutual funds are push products in India and there are no real incentives for anyone in recommending passive funds.