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Last Updated : Sep 20, 2019 10:33 AM IST | Source: Moneycontrol.com

Even in India, it is hard for active fund managers to outperform the market: Morningstar

If you're having or if you're trying to have a large-cap exposure, passive investing, especially if it is at the right price, can make sense for a lot of investors.

Nikhil Walavalkar @nikhilmw

Indian markets have been volatile over past year and a half. Equity investors have been a worried lot as not just mid- and small-caps, but even large-caps are witnessing steep declines in share prices. Even as large-cap funds struggle to beat benchmarks due partly to higher costs, index investing is catching up in India. This follows the global mood of embracing passive investing using exchange traded funds (ETFs) that track frontline equity indices. Joan Schaper, head of index products, Morningstar Inc. spoke to Moneycontrol on the rising popularity of index investing. Excerpts:

Q: What are the new trends unfolding in developed countries as far as index investing is concerned?

A: There is a huge push for passive investing. It is going on for years. As active fund managers are finding it difficult to beat the benchmarks, we see this trend of shift from active fund managers to index investing getting accelerated.

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Source: Morningstar

ESG (Environmental-social-governance) investing is also catching up. Climate change is a driver behind this. There is a huge institutional interest and the individual investors are catching up.

There is also a trend of reducing the cost associated with benchmarking. Asset managers and investment advisors are under pressure to reduce the fees. There is a focus on low cost. As access to data is becoming cheaper and technology too is becoming less expensive, indexing should become cheaper. In a step in the direction of cheaper indices is open-ended index on the line of open source software. Note that the fees that are paid to the entity that designs the benchmark ultimately are passed on to the investors by the asset managers in the form of higher expense. Since 2016, Morningstar has taken up the project of open-ended index. We have approximately 100 equity indices on offer for free. These benchmarks are free for investors and hence the cost of benchmarking goes down.

Since 2016, Morningstar has taken up the project of open-ended index. We have approximately 100 equity indices on offer for free. These benchmarks are free for investors and hence the cost of benchmarking goes down. We have 134 asset managers or asset owners globally who have subscribed to our indices. Assets under managed worth around $12 billion are being invested in products where these open-ended indices are primary indices.

Is it wise to invest in smart beta or fundamentally weighted index funds? What is the global experience?

We call it strategic beta. We avoid using the term smart beta. Because I think some of the indexes have performed well, and some of them haven’t. The success of the investment strategy depends on the fundamentals of the strategy and investors need to be careful just as they would while choosing actively managed funds.

Investors need to be really careful to make sure that they understand the underlying rationale, the rules behind the index. The rules can be good and produce great outcomes or the rule could make no sense.

Q: Should Indian investors go for index investing when there is scope for outperformance? What are the precautions that investors should take?

A: Even in the Indian market, it is harder for active managers to outperform the market. And so if you're having or if you're trying to have a large-cap exposure, passive investing, especially if it is at the right price, can make sense for a lot of investors. If you want to invest in equities, a passive broad market strategy through an index ETF can be really appropriate for investors. Because it should be at lower cost, the passive strategy should be cheaper than active.

You will always have to be careful with how the index is constructed, and how much concentration there is in an index. So, in the Indian market, where some of the biggest stocks comprise a huge percentage of the benchmarks, investors need to be aware.

In the Indian market, there aren't very many market makers, and the units of ETFs are not as liquid as they are in developed markets. Investors must keep this in mind while transacting in ETFs.

Investors need an asset allocation strategy. You should be taking into account your risk appetite and how close you are from your financial goals. You must understand that large-cap stocks are less volatile compared to small-cap stocks. Small caps may have more downside. You should not invest all your money in one asset class or one product – do not go for only equities or only bonds. Having a diversified portfolio of large-cap and small cap stocks, and fixed income can help overcome volatility.

Q: Sophisticated investors do look at structured products while investing in indices. Is it a wise approach?

A: Structured products and index funds are going to coexist. Structured products are targeted at different investors with different needs. ETFs, are viewed as low cost and efficient way for investors to take exposure to index. Structured products, because a lot of them have this guaranteed option, do come with higher costs.

Q: SEBI has in-principal approved the introduction of commodity indices. How is the idea of investing in commodities using index funds or mutual funds?

A: Commodities are an important asset class and can play an important role in an individual’s portfolio, especially when they're worried about deflation. In the last few years, commodities have not done well. So there's been less interest in them. But institutional investors and even for more sophisticated investors, you do see commodities in their portfolio. A commodity index, or a mutual fund or an ETF based on a commodity is a very rational way of getting that for sure.
Not sure which mutual funds to buy? Download moneycontrol transact app to get personalised investment recommendations.
First Published on Sep 20, 2019 08:52 am
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