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 In
the previous issue, we talked about equity funds. In this issue,
we will take up a specific fund. The idea is not to promote a
specific fund, but a brilliant investment idea. The specific idea
that we are going to discuss is very general. Equity investing is
quite emotional for most of the investors. There are numerous
examples of investors trying to beat the overall market and
extract something extra in form of either higher upside or lower
losses. As discussed in the previous article, there are various
types of funds. All the different funds (except Index Funds) are
actively managed by fund managers in order to generate better than
average returns. There is a very strong human psychology working
behind these attempts. In most cases, the expertise is defined as
being able to do better than the average. If you look at a cricket
team, the best batsmen of the team have better batting averages
than the average for the team. Same is the case with the best
salesperson, whose sales averages would be better than the average
for the entire sales team. Similarly, the expectation from a good
fund manager is that he / she will be able to beat the market
average at all times. |
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 In
the Indian stock markets, for a very long period, it was possible
for expert fund managers to do better than the market indices.
However, over last few years, it is becoming increasingly
difficult for individual fund managers to consistently beat the
market averages. Those who outperform the market in one time
segment may underperform in the next one. For average investors,
it is almost impossible to pick up the star fund manager of the
future. So many decisions
regarding fund manager selection are based on the performance in
the recent past. The standard mutual fund risk factor that "past
performance may or may not be sustained in future" is often
ignored. Having said this, there are a few reasons due to which
outperforming the market averages is becoming difficult. |
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These
reasons are:
There is an increasing presence of institutional investors, who
are better equipped than retail individual investors. These
institutional investors account for a much bigger part of the
market averages, thus reducing one another's ability to
outperform. If we take the star batsman example, a star batsman is
expected to have a higher average than most of his teammates.
However, if the same star batsman is a part of the World XI, the
batting averages of most of his teammates would be quite similar.
(There has been no batsman to reach anywhere close to Don Bradman
in terms of batting average.
Active fund management is subject to the risk of the fund
manager's decisions going off the mark. Equity investing is all
about anticipating the future of the company and buying (or
selling) the stock much before others recognise the potential
(gain or loss). The assumptions and analyses may go wrong. In such
cases, even some of the best fund managers may also underperform
for a prolonged period.
Active management means higher costs – first the expense ratio of
an actively managed fund is higher than its passive counterpart.
Then there are invisible costs associated with trading. (Since the
trading and other incidental costs are adjusted in the purchase or
sell price of the securities, we have used the word invisible. |
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The bid-ask spread is another invisible cost. The bid-ask spread
is the difference between the price at which you can buy a stock
and the price at which you can sell a stock. The spread becomes
wider for illiquid stocks or stocks of smaller companies.
Larger portfolios have another limitation that any trade from a
large portfolio has the potential to impact the price. The impact
is always going to be against the interest of the portfolio
manager. If the manager of a large portfolio wishes to off-load a
stock in the market, the very act of the fund manager will result
in falling price.
These costs can be minimised in a very smart way, known as
indexing, which is passive investing as explained in the previous
article. The portfolio replicates a leading stock market index and
the returns an investor can expect are very close to the movement
of the index.
Why have we dedicated this article to indexing? It is a complete
branch of investing with a very large fan-following among many
academicians, researchers and investors worldwide. In India,
indexing is still a new concept. So far, the investor had an
option to invest only in the index funds mirroring the narrower
indices like Nifty, Sensex, Nifty Junior or some of the sectoral
indices like Bankex. However, now the investors will have an
access to the entire stock market through Benchmark S&P CNX 500
Fund, launched by India's largest index fund manager Benchmark
Asset Management Company Pvt. Ltd. Benchmark S&P CNX 500 Fund can
also be called the total stock market fund. This is the best
investment options for an investor convinced about the India
growth story. Investment in this fund gives access to over 90% of
the market capitalisation, through 500 stocks coming from all
sectors, industries and sizes. I think all investors should build
their portfolios with this fund at the core.
The advantages to an investor are quite stark: participation in
the India growth story without having to worry about selecting the
best stocks or the best funds at very low costs. Whichever part of
the market benefits from the India growth story, the investor is
present to reap the benefit of the same. |
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To be continued |
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Amit Trivedi |
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The author runs Karmayog
Knowledge Academy. The views expressed are his personal opinions.
He can be reached at karmayog.
knowledge@gmail.com |
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