The Hindu Business Line : Passive index funds lag behind active funds

Though the passive index funds are gradually gaining popularity in the country, they are still lagging behind the active funds, a recent report by India Knowledge @ Wharton said.

Data on mutual funds returns suggest that the average index equity fund delivered a return of 43.52 per cent against the average annual return of 47.51 per cent by the diversified open-ended equity funds, which are actively managed, as of November 2007.

According to Value Research, the country’s leading mutual fund tracker, in the past two years, passively managed and low-cost index funds returned close to 46 per cent annually, while their counterparts in active and diversified equity funds averaged around 45 per cent.

Year-to-January 21, according to Value Research, actively managed Standard Chartered Premier Equity Fund posted a return of 83.41 per cent, while the passive Birla India Opportunities Fund fell 3.84 per cent.

Discerning investors

According to Association of Mutual Funds in India (AMFI), there are about 253 equity mutual funds including active funds, index funds and quant funds. Between October 2006 and October 2007, assets under management in these funds grew by 80 per cent to Rs 5,56,730 crore.

Mr Robert Stambaugh, a Wharton finance professor, says that while it is theoretically impossible for the average active fund to outperform the average index fund, discerning investors would look out for those fund managers who make the most of market imperfections.

“If one could figure out which active fund managers are going to outperform (the index), then the market conditions under which they are likely to produce the most returns would be those where the market is inefficient and where prices don’t correctly reflect all available information,” he says.

Active managers

Prof Stambaugh is of the opinion that a market where prices are essentially wrong, would give the opportunity to the best active managers. “But even in that type of market, the average active manager cannot beat the index,” he adds.

The report tends to conclude that active funds are likely to dominate the Indian market for a few more years until investors get better educated about passive funds.

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