Does Investing in Index Fund Make Sense Now?

Apr 25, 2020



The equity market started showing some signs of stability since the beginning of April even as COVID-19 cases continued to rise in most parts of the country. Stimulus from the government and RBI, news that cases are peaking globally, crude oil crash and hopes of strong pickup in the future, among other factors brought back investor sentiments.

This offered some respite from the severe market crash of the past month when the equity market declined by nearly 23%. Owing to the volatility, index funds witnessed a sharp inflow in March 2020, as per the latest data available from AMFI.

Inflows in index funds were at Rs 2076.5 crore in March, as compared to Rs 511.5 crore in February and Rs 146.8 crore in January.

In the wake of heightened interest in index funds, L&T Mutual Fund recently launched L&T Nifty 50 Index Fund and L&T Nifty Next 50 Index Fund, while Motilal Oswal Mutual Fund came out with Motilal Oswal S&P 500 Index Fund.

Graph: Index funds witness sharp rise in inflows in March

Data as of March 31, 2020
(Source: AMFI)

There are few things that make index funds worth looking at...

In a falling market such as the one we are witnessing now, index funds become a suitable option for conservative investors who want to avoid the repercussions of volatility. It can become difficult for investors to pick the right funds from the plethora of within various mutual fund categories and sub categories when most equity funds have witnessed significant drop in NAV. So, if you are looking for returns on par with the market, index funds can be worth looking at.

In the past couple of years many actively managed funds, especially in the large cap fund category, failed to beat the index as only a few index heavyweights have been driving the rally. This along with low expense ratio made passive funds attractive for investors.

If you choose an index fund with low tracking error and low expense ratio, it can help you generate higher returns than the index provided you invest for the long term.

However, keep in mind that market crash impacts index funds as well. Unlike index funds, actively managed funds are better poised to take advantage of dynamic market conditions. During the market crash, the actively managed funds get the opportunity to pick strong companies available at attractive valuations. Hence, they can outperform the market with remarkable margin during recovery and bull phase.

Besides, most index funds usually track large cap index. This prevents you from taking advantage of growth in broader markets. If you want to create a diversified portfolio of funds, actively managed funds can be a worthwhile option.

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In an emerging market like India, active fund managers have lot of opportunities to capitalise upon and generate significant gains for its investors.

So if your strategy is to get alpha-generating returns, index funds may not be the right option for you.

An actively managed equity fund amidst the turbulent times can display its ability to generate 'alpha' (multiply wealth in the long run) if the fund manager handles the portfolio well.

Given that market valuations have corrected from earlier highs and there's attractive valuations and a sufficient margin of safety, it creates the right climate for active fund managers to go value hunting with a number of stocks trading lower compared to their 52-week high. So, if you wish to multiply your investment returns in the volatile times, build an equity mutual fund portfolio with Alpha Funds.

Some process-driven funds have the ability to beat the markets under any conditions and can create significant alpha for investors.

PersonalFN's The Alpha Booster Strategy is one service that aims to identify such high alpha generating funds. It has already helped hundreds of investors pick high potential funds that may benefit them with superior returns in the long run.

The present market condition makes it the right time to get your hands on high alpha generating funds.

That said, the decision on whether to invest in an actively managed fund or index fund, or a combination of both should depend on financial objective, investment horizon and risk taking ability. Do not take undue risk in the hope of high returns.

 

Warm Regards,
Divya Grover
Research Analyst

 

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