At Personalfn we have agonised over this question and have come up with some answers. One reason why index funds do not make it to the investor's must-invest list is because they are perceived as too dull and boring. When you have actively managed funds that are doing a very good job, who has money for 'slowcoaches'?
Over the last 18-24 months, ask any aggressive mutual fund investor where he has put his money and you will learn that most of it has found its way in small/mid cap funds, thematic funds and flexi-cap funds. This is only to be expected given the blistering performance of these funds.
You ask the aggressive investor why he has not considered investing in index funds and he will give you that puzzled wondering whether you are trying to guide him or misguide him.
Make no mistake that an invitation to invest in index funds is not imprudent. On the other hand, the notion that all actively managed funds do a better job than index funds in delivering growth is definitely misguided.
Investors who believe that it is best to stick with actively managed funds should consider the 1-year performance of some of these large cap funds.
All that glitters is not gold
| Diversified Equity Funds | NAV (Rs) | 1-Mth | 6-Mth | 1-Yr | 3-Yr | Incep. |
| PRINCIPAL EQUITY | 26.14 | 9.60% | 25.31% | 48.44% | 43.37% | 10.23% |
| FRANKLIN BLUECHIP | 85.89 | 11.14% | 34.41% | 48.06% | 58.65% | 29.40% |
| UTI THEMATIC LARGE CAP | 14.93 | 9.78% | 28.71% | 47.24% | - | 29.14% |
| SUNDARAM GROWTH | 44.77 | 11.55% | 31.01% | 46.19% | 55.19% | 24.23% |
| HSBC EQUITY | 47.78 | 8.46% | 32.01% | 45.83% | - | 68.94% |
In our sample we have taken the large cap/predominantly large cap funds. These funds are benchmarked against large cap indices like BSE Sensex and S&P CNX Nifty. They even own a lot of stocks from these indices but in varying proportions.
The idea is to outperform the index; in fact that is the reason why actively managed funds exist -- to show the investor that the index can be outperformed. Some of these large cap funds like Franklin Bluechip, HSBC Equity and Sundaram Growth are renowned names with established track records. Note their 1-year performance. Now compare this with index fund performances from the table below.
Index funds do the job well enough
| Index Funds | NAV (Rs) | 1-Mth | 6-Mth | 1-Yr | 3-Yr | Incep. |
| UTI MASTER INDEX | 27.69 | 10.97% | 33.62% | 47.30% | 41.52% | 14.26% |
| FT INDIA INDEX SENSEX | 25.14 | 10.71% | 33.34% | 46.33% | 37.42% | 24.69% |
| HDFC INDEX SENSEX | 83.08 | 10.49% | 31.95% | 44.89% | 37.27% | 32.30% |
| PRUICICI INDEX | 23.27 | 11.19% | 32.13% | 44.43% | 38.00% | 25.84% |
| LIC INDEX SENSEX | 19.00 | 10.79% | 26.68% | 41.74% | - | 28.12% |
You will notice two things on comparing the tables. Actively managed funds have by and large outperformed index funds (all the index funds in our sample are aligned with the BSE Sensex). The quantum of outperformance is not very significant and is far from what one might call comprehensive.
Another way to look at this is that index funds haven't really done a bad job for the conservative investor just like actively managed funds haven't really done a great job for the aggressive investor.
Another point that should not be lost on the aggressive investor is that most index funds work at half the cost of actively managed funds. This implies that index funds have put in a reasonable performance vis-à-vis actively managed funds at relatively lower cost.
Of course, we have taken a shorter investment time frame of 1-year, while equity-linked investments really need to be considered from a 3-5 year perspective.
Over that extended a time frame, you will see that actively managed funds have outperformed index funds significantly.
This should tell investors a couple of things. One is that well-managed active funds need to be a part of your portfolio because they tend to pitch in a superior performance over the longer term (3-5 years).
At the same time index funds don't necessarily deserve to be snubbed. Investors have to diversify their mutual fund portfolio in a manner that ensures they are well placed to benefit from most if not all market opportunities.
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