Monday, December 3, 2012

Index Funds or Active Funds???

 
 Index Funds mirror their respective Benchmark Indices and Diversified Equity Funds follow Active Investment strategy and are in constant search of stocks to generate Alpha returns in respect of their benchmark indices.

The management of Index Funds is easy as no decision is needed on stocks to buy, sell, hold as the Fund just tracks its Benchmark accurately.

Since, the Index Funds just mirrors the Index, there is no chance of it beating the Index. Sure, it can't do bad either.

Of course, some Index Funds deviate here too. For ex :
For 1 year period, ICICI Pru Spice Plan gave a return of 20.4%, in the same period, the Franklin India Index- BSE gave a return of only 17.5%
For a index fund, doing better or worse than its Benchmark Index is a sign of Bad Management.





Active funds

If an investor had invested Rs.1 Lakh 5 years ago in IDFC Premier Equity Fund, the value would have been Rs.1,63,808.

If the same investor had invested his Rs.1 Lakh in Franklin India Index Fund - BSE Sensex Plan, the value would have been Rs.99,773.

Clear indication that Active Managed Funds fare better, much much better than Indicies over a long time frame.


CASE FOR INDEX FUNDS :
1. Since no research is involved and no active trading is involved, the charges are low.
Yes, Active Funds do have higher expenses, but they also have consistently delivered higher returns.
Give me fund which delivers higher returns with higher costs any day over the fund which delivers lower returns with lower costs.

2. Since the Funds mirror the Index, the level of risk is low
CASE AGAINST INDEX FUNDS :
1. Most Index Funds invest in  Large Large Caps and typically these stocks tend to be very expensive stocks.

2. In Index, stocks are taken out when it is nearly near its downward spiral (business wise and stock price wise), thus the Index Funds are forced to stay with the stock inspite of knowing that the stock will go only way - down. Ex : Reliance Comm was exited by Majority of Active funds before it was taken out from Index, but Index Funds were forced to stay put in the Stock.

3. Index fund managers also don’t start buying the newly added companies until they’re officially added while active managers already have the new (and better) stocks in hand.


CASE AGAINST ACTIVE FUNDS :
1. The Fund Manager could pack his bags and leave the Fund and its investors high and dry.
This, however, is mitigated in most fund houses, as they believe in "process and system" rather than in genius of Star Fund Manager.
2. The level of risk is higher.

FINALLY,
The primary difference between passive funds and active funds; one is content at giving index-linked returns, while the other consciously tries to outperform it.








The past records have proved that Active Funds have consistently outperformed Index Funds by a fair margin. In fact, Active Funds have beaten the broader indices like the BSE 200.
As they say, Be ACTIVE, enjoy life.
Also visit http://equityadvise.blogspot.com

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