(This post is contributed by another Guest Strater – Payal Wadhwa, who is an Index Fund and investment expert. Her article is part of her project to spread awareness about Index funds and investments – Active and Passive investments. Strat . In thanks Payal for her contribution, wishes her all the luck in her endeavours and looks forward to further insights from her. )

As the election results were announced and the markets shattered previous records it was time to do analysis of index funds versus the expertise of ‘active management.’ It appears that the only ‘past performance’ that repeats without fail are the predictions of many experts-whether it is election results, individual stocks, market timing, identifying outperforming MF schemes, whether large caps will do better or mid caps and so on.

Let us have a look at the enclosed spreadsheet which shows the comparison of three index funds with 31 diversified equity funds-selected at random.

The three index funds are the options actually available to Indian investors i.e. CNX-500, Nifty and Junior BeES. The dates selected are 13th January 2009 to 19th May 2009. The start date is the same date on which the CNX-500 became open for continuous purchase after its NFO. That means investors had the option of buying the entire stock market via a CNX-500 index fund and in the process eliminate the guesswork of selecting individual stocks, managers, sectors, large caps, mid caps, timing and so on.

As we can see from the excel file a low cost index fund investor who eliminated all guesswork has done much better than high cost actively managed schemes. None of the schemes selected at random have done better than the ‘market portfolio’ i.e. CNX-500. We have read in various reports that managers have missed the rally. As an investor we are concerned with the bottom line i.e. the risk adjusted return via a low cost index fund.

MF data is publicly available hence we can do its analysis-we don’t know what is the fate of other actively managed portfolios like PMS schemes, portfolios managed by advisors, treasuries, family offices, ULIPs and so on? The market is the combined knowledge of lakhs of investors and it knows more than individuals. An individual may ‘out guess’ the market once in a while by getting lucky-if it is skill then it has to repeat consistently.

The iron clad mathematical law of the market is ‘gross returns in the market minus the substantial costs of intermediation is the net return actually earned by investors as a group.’ Also find attached a study which looks at trend of out/underperformance of Active Fund Managers in India over Index Funds named Myth of Eternal Alpha.

Excel-sheet-mf-vs-index-funds

The myth of eternal alpha – An insight into the Index fund basics

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