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Should You Be Investing In Passive Funds Now?    Dec 07, 2018


Do you wait until good things happen for you, or do you like to work hard to achieve them?

Proactive people don’t wait until a good fortune shines on them. They choose their path, set their goals, and strive to accomplish them without disputing the luck factor.

On the other hand, passive people hope that their fortune will favour them someday if they just keep going with the flow.

It isn’t different when it comes to investing in equity mutual funds.

Some mutual fund investors believe that if the fund manager of an actively managed fund commits a mistake in selecting stocks, their portfolio could do badly. They doubt human abilities to choose good companies on a consistent basis. Having said that, they recognise and acknowledge the importance of equity as an asset class.

In other words, passive investors believe in the return potential of equity assets, but they are apprehensive about active portfolio management. Hence, they invest in passive funds that mimic an index.

The fund manager of an actively managed fund invests in companies that could possibly generate index-beating returns.

Table: When averages lie…

Absolute (%) CAGR (%)
YTD 6 Months 1 Year 2 Years 3 Years 5 Years
Average returns generated by passively managed funds 2.3 1.3 6.6 16.4 12.0 12.9
Average returns generated by actively managed funds -7.8 -3.6 -3.5 13.2 11.1 17.9
Highest returns generated by an actively managed fund 8.0 4.1 11.9 22.2 17.6 32.3
NIFTY 50 – TRI 4.8 2.5 9.0 17.5 12.9 13.3
NIFTY 500 – TRI -2.6 -0.6 2.0 16.0 12.5 15.0
Data as on December 3, 2018
(Source: ACE MF)

Given the lacklustre performance of actively managed funds in the recent past, many experts have started doubting the role of actively managed funds.

So, is this the time to shun actively managed funds and invest only in passive funds, hoping that your investments would do better when they are in sync with the market performance?

Passively managed funds

In India, passive management of funds is relatively an unpopular concept, because investors tend to chase returns. A majority of passively managed funds offered in India mimic the Nifty or S&P BSE Sensex.  The other categories of passively managed funds, such as strategy-based funds, are yet to evolve.   

In their present form, sometimes passively managed funds generate slightly lower returns compared to their underlying benchmark indices. This is primarily because of the tracking error and to an extent the expense ratio.

However, it won’t happen that an index fund is generating negative returns when the broader markets are doing well, i.e. generating positive returns. Therefore, it’s perfectly fine to invest in passively managed funds.

But if you avoid actively managed funds completely, you miss out on the chance of earning alpha returns   – to put it simply, the potential of earning market-beating returns.

Actively managed funds

So far, actively managed funds haven’t disappointed investors. However, after the Securities and Exchange Board of India (SEBI) mandated mutual funds to benchmark their performance against Total Return Indices (TRI) recently, the quantum of outperformance of actively managed funds has noticeably reduced. However, that’s not true for all actively managed mutual fund schemes.

Certain well-run actively managed mutual funds have not only outperformed their benchmark indices and passive funds, but even outshone some of the peers in the actively managed fund category.

Be cautious if you are investing in some of the popular actively managed funds…

Popular mutual fund schemes enjoy 4-star, 5-star ratings from many multiple mutual fund rating agencies that depend solely on quantitative rating parameters. Now, while this approach of assessing the schemes’ past track record isn't necessarily ineffective, it cannot be an indicator of how the scheme will perform in the future – whether it will continue to create wealth for its investors or not.

[Read: Are You Still Looking For The Popular Funds Out There? Read This!] 

To know the stars of tomorrow, one must consider the important qualitative parameters such as the investment philosophy of a fund house, its investment style, portfolio characteristics, fund managers’ experience, along with the track record of schemes they manage.

These qualitative factors are more pertinent than historical performance to judge the future growth potential and consistency of the fund. So, while the quantitative factors could be just a starting point, you need to delve deeper and understand the qualitative aspects too; because if you ignore the qualitative factors you may never get to the real stars of tomorrow.

[Read: Why Qualitative Aspects Are So Important To Pick Mutual Funds]

If you want to benefit from your investment in actively managed funds, you should be ready to select undiscovered funds over popular funds. Compared to popular funds, they have the potential to perform far better as you endeavour to create wealth. 

At PersonalFN, we term such undiscovered funds as hidden gems.

But any small sized fund will not do. You do not want to pick lesser-known funds that have delivered a one-off performance. You need the ‘right’ ones that have the potential to generate wealth for you.

Identifying undiscovered funds is a skilled job

stragicy
(Image source: unsplash.com)

PersonalFN follows the S.M.A.R.T. Score Matrix. This means that mutual fund schemes are selected on the basis of five variables:

Systems and Process

Market cycle performance 

Asset management style 

Risk-reward ratios 

Performance Track Record

Do you want to own undiscovered funds in your portfolio, but do not have the skills or the time to conduct extensive research by yourself?

PersonalFN’s special report 5 Undiscovered Funds is just perfect for you. But before you invest in undiscovered funds, recognize your risk profile and investment objectives.

Believe us, unusual and lesser-known funds are capable of generating big gains for you. Some hidden gems are managed well and have the potential to deliver superior risk-adjusted returns in line with the popular peers in the category.

PersonalFN has tested the viability of Undiscovered Funds featuring in this report by applying a stringent selection process. What are you waiting for? Subscribe to the special report, 5 Undiscovered Funds today!

To know more, click here.

 

Author: PersonalFN Content & Research Team



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