18/03/2018 Sorry Mr Buffett, your advice of index fund investing not best choice in India - The Economic Times

Sorry Mr Buffett, your advice of index fund investing not

best choice in India
BY KSHITIJ ANAND, ETMARKETS.COM | UPDATED: FEB 28, 2017, 12.24 PM IST Post a Comment

NEW DELHI: Berkshire Hathaway Chairman Warren Buffett, admired across the globe
Big Change:
not only by the analyst community but also retail investors, said investors should “stick The end of Five-Year Plans: All you need to know
with low-cost index funds.”

This guru mantra might work for investors in the US or any other developed market, but
may not be that effective in India, at least at the current stage of evolution of the Indian
equity market, say market analysts.

Buffett, widely considered one of the world’s best equity investors, said in his annual letter to shareholders that trillions of dollars are
managed by Wall Streeters charging high fees and it is best that large and small investors stick with low-cost index funds.

“Buffett’s quote is relevant in the US context, where majority of funds underperform the benchmark index. It is not relevant in the Indian
context, where majority of funds outperform the equity benchmark,” Nilesh Shah, MD, Kotak AMC, told ETMarkets.com.

“However, his quote is an undeniable universal truth that cost is an important part of return on investment. If your cost is high, then
returns will get diluted to that extent. Keep a watch on cost vis-à-vis return,” he said.

So, what is an index fund?

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As the name suggests, it is a fund that invests in an index. In other words, the scheme will perform in tandem with the index. The
management fee for index funds is less compared with that for managed funds.

“There is enough data to support that active fund managers have a role to play in emerging markets like India, which are not most
efficient,” Nilesh Shetty, Associate Fund Manager for Equity at Quantum Mutual Fund, told ETMarkets.com.

“But yes, the cost of investments matters a lot. Over the long term, a high cost structure will most likely underperform the benchmark,”
he said.

For example, the SBI Nifty Index Fund has an expense ratio of 0.70 per cent, whereas an actively-managed fund such as SBI Bluechip
fund charges 1.98 per cent (as of January 31, 2017). UTI Nifty Index Fund has an expense ratio of 0.2 per cent.

When investing in an index fund, it is important to take into account the tracking error, which is nothing but the difference between the
returns of the index fund and the benchmark index.

Some schemes fail to mimic returns given by the index, but that is one of the reasons why active fund managers play a key role in
adjusting the portfolio to generate alpha for unit holders.

Smaller size of the Indian mutual fund industry vis-à-vis the equity market capitalisation and lower market efficiency relative to other
developed markets seem to support alpha generation by Indian fund managers.

“Buffett’s principle of index investing may not be meaningful for Indian investors, at least at the current stage of evolution of the Indian
market (in terms of market efficiency and size),” Dhaval Kapadia, director, investment advisory, Morningstar Investment Adviser (I), told
ETMarkets.com.

“The asset under management (or AUM) of the Indian mutual fund industry stands at over $265 billion, which is approximately 13 per
cent of the total market capitalisation of the Indian equity market vis-à-vis the AUM of the US mutual fund industry, which stands at
around $17 trillion and 85 per cent to its equity market capitalisation,” he said.

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18/03/2018 Sorry Mr Buffett, your advice of index fund investing not best choice in India - The Economic Times

“A fair proportion of Indian mutual funds has been known to outperform the benchmark indices after expenses on a consistent basis
over various time periods such as one year, three years, five years and 10 years," Kapadia said.

Morningstar data showed the success rate of Indian largecap funds in terms of outperformance to benchmark index over one year and
10 years stand at 50 per cent and 75 per cent, respectively, while for smallcap and midcap funds, this ratio stands at 32 per cent and
80 per cent over one year and 10 years, respectively.

Be stock specific or bet on actively managed funds:

If the objective is to seek higher returns, then investors will be better off investing in individual stocks or thematic funds, say experts.
Because, there are many companies that can generate returns higher than the index.

In India, due to the smaller size of mutual funds compared with those in the US, the evolving nature of the economy is not being fully
captured in the benchmark indices, which create scope for local fund managers to outperform the benchmark index, says Shah.

As long as actively-managed funds are able to outperform the benchmark indices and create value for the investors, index funds will
not be an ideal option, he said.

Actively-managed funds have outperformed significantly due to fund managers’ ability to find quality value-based scrips (Midcap and
Largecap space), which offer a trillion-dollar opportunity.

“There are many fundamentally-sound stocks available outside the major indices. Investing only in index funds could kill the opportunity
to make money from quality stocks, just because they are not part of the index,” Tushar Pendharkar, Head of Research at Right
Horizons Investment Advisory Services, told ETMarkets.com.

“Stocks like Godrej Consumer, Dabur India, Motherson Sumi, Va Tech Wabag are still not in the index, but they are good names. A
year back, Eicher Motors and Bosch were not in the index, but they performed significantly well compared with any name from the
index,” he said.

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