Investment for such people is an activity where there is a lot of action all the time. They strongly believe that to get returns one needs to actively manage their portfolio and churn appropriately.
This is an active management strategy. Even in mutual fund schemes, we have schemes where the fund manager manages the scheme portfolio by picking appropriate candidates from the universe of stocks at his disposal, as per the mandate of the scheme. Of course, the fund manager is an expert in portfolio management, and has the education, experience and expertise to manage stock portfolios. He is also supported by his team of analysts who research the stock universe, economy, specific sectors and feed other relevant information to aid the fund manager to make a well reasoned investment choice for the portfolio.
Such funds that rely on the fund manager skill to pick the right equity/ debt components in the portfolio is what is called active fund management.
While managing a portfolio for various investors, the fund manager will charge a professional fee for the services. That will be justified if he is able to generate a return over the chosen benchmark, after accounting for the fees. But that has become difficult, especially in the large cap space as these stocks are extensively covered by analysts and there is not much exclusive or privileged information that a fund manager could cash in. Hence, in this space most actively managed funds are struggling to beat the index.
Hence, it may be a good idea to just invest in the index itself. That is what passive investments are all about. The investments are made exactly in the same proportion as a chosen index and rebalancing is done periodically to reflect the underlying index.
It cuts out the discretion of the fund manager to choose stocks and hence the fund manager related risk is taken out of the investment equation by investing in Index funds. The costs associated with the passive investment is less as the fund manager and team have no real role to play in the stock selection.Due to all this, at least in the large cap space passive funds have become a viable alternative that we suggest. We started recommending this in the past few years. In case of mid and small cap funds, a good proportion of the actively-managed funds are able to beat the index, even after accounting for the higher charges. Hence, in this space we are suggesting actively managed funds for the most part.
If one wants to participate in the whole market, one could invest in the Nifty 500 index, which gives unparalleled diversification to the entire stock universe. Investing through such an all market index also ensures that we capture the wisdom of all participants in the markets, with all significant information considered and discounted and the ultimate price reflecting that. This is a very simple way to participate in the stock markets and we do recommend this too.
International investment has gained currency. However, picking stocks in another country may not be that easy as one needs to understand the company, industry segment and dynamics, the economy structure of that country and the potential for the stock to perform in the future. This is somewhat beyond just financial analysis. For good investments one needs deep understanding and insights about various aspects affecting the company and its offerings.
Hence, in case of investments abroad, we would prefer the Exchange Traded Fund (ETF) route, which is again a passive investment option. Incidentally, ETFs abroad, which are available around many popular underlying indices, are a good route. Incidentally, abroad, almost the entire lot of actively-managed funds in a category are not able to beat the corresponding ETFs. Also, the charges for these ETFs are very low – under 0.1% pa of the assets managed.
There are Fund of Funds (FOF) created around these ETFs from abroad, like S&P 500, Nasdaq 100 etc. Such FOFs invest the collected funds into the ETF abroad. One can invest in rupees through the usual MF route, with the same taxation applicable like an Indian FOF, making it easy to invest and manage.
From the aforementioned arguments, it must be clear that there is a space for passives in some segments and a role for actively-managed funds elsewhere. A good advisor needs to be agnostic and should choose investments on merit. As advisors one needs to carefully consider what a good portfolio should contain and do what is good for the clients overall.
Suresh Sadagopan is MD & Principal Officer at Ladder7 Wealth Planners and author of If God was your Financial Planner.
