The COVID induced slowdown has made many investors wary of stocks. Long-term investments in equity funds have delivered single-digit returns and many actively managed schemes are underperforming benchmarks. In this backdrop, should investors consider passive investing? Vishal Jain, Head, Nippon India ETF gives his take on investing in index funds and ETFs.
Volatile markets make many experts call for active management of portfolios. So, will passive investing take a back seat in such times?
Passive investing believes that the price of the stock captures all the information available and emotions of all investors. There is little possibility that a fund manager will consistently beat the index across time periods. And hence, index investing will always be relevant in investors’ portfolios. We are going through the COVID-19 crisis and the markets are down. You do not know what will happen six months or one year from now. You do not know which stock to buy for investment purpose. It is more likely that the investor would like to pick up the best stock in the market. And the easy way out to do that is to invest in the Nifty index.
In mid-caps, most investors prefer active investing. How should investors look at them as actively managed funds typically outperform the benchmark?
Investors face a problem of choosing an actively managed scheme that will outperform in future. In this quest to pick the best stock, best sector or the best mutual fund scheme to earn ‘extra returns over market returns (alpha),’ many times, investors do not even earn ‘market return’ or return delivered by the index (beta). If you believe that the Indian economy is going to do well over a long period of time, it makes a lot of sense to first invest in an index fund and earn index returns. Investors must take a core and satellite approach to investing in equity funds. The core of your portfolio should be in passive funds and you should consider mid cap index funds in it. The satellite portion can be in a strategy that you believe could do well.
Have smart beta exchange traded funds (ETF) worked?
Globally, smart beta funds have not done well. In the international market, most smart beta funds are based on dividend yield because interest rates in those markets are at near-zero levels, not because these strategies outperform.
Smart beta ETF is active management strategy wherein allocation to stocks is based on a rule or a combination of factors. It is difficult to predict which strategy will do well in the future. If an investor is keen to take additional risk, she can invest in them as a part of the actively managed equity portfolio.
The costs of the Nifty index ETFs are as low as 5 basis points. How long would this low pricing last?
Expense ratios should remain stable. Passive products are low-cost investments and the benefit of saving in costs is passed on to investors. Our expense ratio has gone down with the rise in assets under management over a long period of time as economies of scale kicked in.
ETFs suffer from liquidity issues. Very few large ETFs have liquidity. How many market makers should a fund house appoint?
Market makers can place buy-and-sell quotes. But if there is no investor willing to buy or sell at that price, then the market makers on their own cannot create liquidity. Products need to be promoted, marketed in the right manner and demand should come from real investors. If the product is not bought by investors, liquidity will not be there. Rising assets under management is conducive to liquidity. We cannot incentivize market makers, as all ETFs are direct schemes.
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