This isn’t an active vs passive funds post. Am not in the “active vs passive” camp at all, I am rather in the “active & passive” camp. But here are 5 reasons why I “personally” prefer Index Funds in India; over not just actively managed funds, but even ETFs which track the same indices.
1. ETFs – ETF market in India is not that mature yet. We don’t have deep liquidity even in top traded ETFs, so impact cost is too high. Most Indians are watching the US based videos & getting influenced that ETFs have lower fees so ofcourse better than index funds.
But its not true at all. Hardly anyone is tracking their impact cost, including me initially. I am a data guy who loves to play with data & during my initial days of investing, I too used to buy ETFs and then I started tracking my impact cost. Its an invisible fees which everyone is paying but no one is calculating. So when you add Expense Ratio + Tracking Error + Your Personal Impact Cost, there is a very high chance that its way above Index Fund’s “total fees”. Right now at the time of writing this, IndexFundInsights.com is telling me that the cheapest Nifty 50 Index Fund is available only at 0.1% total fee.
Yes there are ways to reduce impact cost by improving the ETF buying process (Which I have already documented in Study Materials section inside SIR Community Telegram group – click here to join) But all those ways will take away hours from your life. Always track the “return after time spent” – If I can get similar or better returns with Index Fund by spending less time on the buying process, why would I go for ETFs.
Fun Fact: On the day of 2024 Election flash crash, one of the most liquid Nifty 50 ETFs – NIFTYBEES was trading at somewhere in between 3-5% premium to iNAV for most of that day. So as soon as you bought it you lost 3-5% in fees.
2. Underperformance – Most people who’re buying actively managed funds always compare their funds with the index (right or wrong – you decide). But that comparison itself brings in bias towards or against a fund if it underperforms for some period of time. Our brains are wired like that – we get uncomfortable if we are “losing” even though that’s ‘unrealised loss’. Most people quit here & change funds.
For example: For years Axis AMC was under performing & people kept exiting or ignoring their funds. Now as many have exited, Axis’ schemes are one of the best performing as of 2024.
I eliminate that bias to a major extent with Index Funds, so its easier for me to stick to the fund. There will always be some AMC outperforming the Index, but not all AMCs at once; so that comparison itself I can’t do. And index going down basically means the market is down. My fund is the market so nothing much to worry about if equity in general is down, there is not much comparison to be made.
3. Outperformance – Index Funds will never outperform active funds. But neither will ‘all’ active funds outperform the index. Am investing for a long enough time & have read a decent amount of market history to make it simpler for you. Below is the simple example of how yearly performance of funds look like
Year 1
Fund A
Fund B
Index Fund
Fund C
Fund D
Year 2
Fund D
Fund A
Fund C
Index Fund
Fund X
Year 3
Fund Y
Fund Z
Index Fund
Fund B
Fund C
Fund D
And so on… So in short, without doing anything Index Fund will always somehow be in top percentile funds while different active funds by different AMCs will outperform it in different years. Basically they will keep going in & out of this list. Now, if you’re thinking you can keep changing active funds & catch the one that will outperform next year among 100s of schemes – god bless you. And if you’re thinking you can consistently do that for decades and post tax still outperform the index – god should bless you more.
Am not that talented in markets or lucky, so personally for me – sticking to simple & dumb index funds is a super easy way to be in top percentile without doing anything from my side. As mentioned above I care more that “return after time spent” metric than just the “return” metric., maybe you should too?
4. Emotion – Humans (all living beings?) often overestimate their ability to stay calm in rush of emotions, especially during this information age. As I have a fairly big X account, so I do get lots of DMs and see people’s replies too; and its very clear that 99% people saying am choosing ABC Flexi Cap scheme for “long term” is overestimating their ability.
quant Mutual Fund got super popular, everyone said I will invest in the schemes for the next 10 years. As soon as news came out regarding the ‘alleged’ front running – many exited the schemes and moved on to Motilal’s schemes (as those were trending then). They said, I will continue with Motilal now for “long term”, quant was just 1 mistake. Then came out allegation regarding Kalyan Jewellers etc. which crashed the stock a lot & Motilal owned that stock in most schemes in high quantity. Same people then exited Motilal too, saying Motilal fund managers are running too concentrated portfolios.
I personally eliminate most of these emotional choices, not because I am different from other humans – but just because the product I chose doesn’t allow me to be emotional. It’s like saving my portfolio from my own emotions, which itself is a huge win. There cannot be any massive ’emotional’ news about Nifty 50 or Nifty 500 or any broad market index fund, whats max gonna happen – there can’t be any front running allegation and 1 or many of those small stocks may crash 20-30% but those smaller stocks hardly have any significant allocation to the Nifty 500 portfolio.
5. Return – Just because my actively managed fund – SIR Fund, is giving 25% yearly return, it doesn’t mean I am getting the 25% yearly return due to the above 3 points.
Sankaran Naren, CIO of ICICI Mutual Fund mentioned that as well. ICICI Value Discovery generated a lot of wealth for 20 years (far more than index), but he says internal data inside ICICI suggests almost no one continued SIP in that fund for that long. Basically, people either stopped investing when it was underperforming for few years or they exited the fund totally.
Legendary fund manager Peter Lynch from USA observed the same thing with his Magellan Fund. From 1977 to 1990, the fund averaged a CAGR of 29.2%. However, Lynch observed that the average investor in the fund only has a return of 7%. Human emotions & actions are same everywhere; me as an investor – my job is to save my portfolio from those emotions, biases & actions.
Anecdotal Realisation: My friends who started investing with me, most of them have either stopped their investments altogether or are underperforming a simple Nifty 500 index fund post tax. And on SIR’s X account, I get multiple such screenshots & DMs of people showing their portfolio with multiple actively managed funds (exited, paused, continuing) – and when I calculate the overall return it’s either the same or underperforming a broad market index; so post tax the person who isn’t even doing all these fund hoping & choosing is outperforming. Was surprising for me too.
Then what to do? I can’t tell you what you should do, what I can tell is what I did for myself to generate the current wealth you’re enjoying – I made my portfolio as simple & dumb as possible. As am optimizing for “return after time spent” rather than “return” metric. And my two main goals are
- To increase the “Invested Amount” in that portfolio. I don’t care much about the “Final/Current Amount” or “Return” metric.
- To stick to the same exact portfolio of funds for a decade or more.
If you’re reading this, just one clarification – everything above is for my kids and I am writing it only for them; so they can read my journey when am not in this mortal body. Or maybe I can feed this to an LLM which can replicate my thought process and my kids can ask the Agentic SIR Bot in my absence. For everyone else, please don’t consider it as investment advice. I am not a SEBI-registered investment advisor, please consult one of them if you need advice.
You dad,
SIR
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