NRIs opting for Index fund or ETF in India is a bad idea. At least the data suggests so. Let’s see in detail & compare both- actively managed funds & passively managed funds or index funds. Investment in Index Funds is still a step away. Let’s study in detail – Why?

An index fund is one of the very popular categories in the Mutual Fund market. In developed countries like USA & European countries, these funds garner more than 50% market of the total managed Mutual Fund AUM.

NRIs also like to make Investment in Index Funds. The main reason behind it because in their country of stay these funds are very popular. Index funds are also known by various names like – Target Date Funds, Tracker Funds or simply passive strategy funds.

What is an Investment Index Fund or a Passive Fund?

In simple words, Index Funds are those funds that track an index of securities. The index can be Sensex, Nifty, Midcap 150, Bank PSU Index or DollEx.

Index funds are also called Passive Funds as they are not actively managed by the fund managers.

These funds construct the portfolio of securities:

• same as present in the index.
• In the same percentage weight as per their respective index.

Investment in Index Funds copy the index and would deliver a similar return as its index does – minus the tracking error.

Tracking error plays a vital role in an index fund. It is the difference between mutual funds’ portfolios returns against its benchmark index.

Tracking error is caused by

• Operating expenses of the fund.
• The price difference of securities when the portfolio is daily rebalanced as per the index weightage.

Here is a previous article detailing construction of Index Funds & Tracking Error.

Should NRI do Investment in Index Funds?

NRIs are making a mistake if they are only investing in Indian Index funds instead of investing in actively managed funds.

A lot of NRI who came to India for investment, they are very keen to invest in Index funds. The basic reason is that these funds are very famous in the bigger markets like the USA.

NRIs who are investing in Indian Index funds are losing the chances of generating higher returns.

Why Not make Investment in Index Funds Only?

These funds generally have low operating expenses because these are not managed actively by fund managers. In India, the cost is still high. In western countries, the cost for some funds is ZERO. Yes, there is no expense fee!

Also, there is no minimum investment to start investing.

Index Funds are enormously popular in developed markets where it is not possible to beat the return of the index consistently for a long period. So it makes sense to invest in Index fund targeting normal returns that index will give.

This is not the case in India. We are a still-growing market. India still has not seen many new sectors like 5G or electric cars. So companies or sectors which can make or disrupt markets have a chance to make above-average returns. Here is a comparison of some popular funds vis a vis there counterpart from the same MF company.

The main reason behind this gap in India is that still, we are a growing economy with lots of potentials. Large companies have a huge opportunity to become a super large cap.

Another reason not to invest in Index Funds is the lack of the Benchmark Indices. We do not have many indexes that can follow broad markets like Russel 1000. Also, many indexes like, Value Index or Bond Index is not present in India.

Hence, India provides a great opportunity for everyone who wishes to invest in actively managed funds than passively managed Index Funds.

NRIs are not advised to invest in index funds in India as of now because actively-managed funds generate an alpha (extra returns) easily of five to eight percent than the index funds.

Point to note here are:

I am not saying Index funds are bad as a product. I am saying:

• There are not many index funds to diversify.
• We do not have a debt-based or commodity-based index.
• Only some large-cap Index funds have been able to challenge actively managed diversified equity funds.
• We have seen Index Vs Active performance in a very small time frame which is a bull market (remember 2019 when only 5-6 large-cap stocks like HDFC twins, SBI, Bajaj Twins, etc performed). We have to see a bear phase also.
• India is developing and is not a matured market where beating index returns is impossible.
• The indexes are not broad-based & large so that they cover the entire market making them harder to beat.
• Portfolio managers still can beat markets with smart stock selection.
• India has portfolio managers who have 15-20 years of experience in dealing with sectors & stocks. (Until Prashant Jain, Bala, Somendranath Lahiri, Nilesh Shah, Gopal Agarwal or Anand say “we are done”, we can full of hope.)
• The cost of active funds is also coming down by SEBI initiatives & competition.

So please give a little more time before you decide to start selling active funds & investing in passive funds. Let us know your experience & question over email or through the comments section below.

(Article Researched by Kapil Kumar Shingari)

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