The Hindu Business Line : Index funds - nothing beyond Sensex, Nifty

The stock market is a no-called-strike game. You don't have to swing at every thing, you can wait for your pitch. The problem when you are a money manager is that your fans keep yelling, "Swing, you bum!" - Warren Buffet, Berkshire Hathaway Annual Meeting, 1999

The wheels of fortune have turned and how! In a financial year that began with a lot of hope for the stock market, diversified equity funds are set to close 2006-07 with a paltry average - less than 10 per cent. Passively-managed index funds have done a shade better, with a little over 13 per cent to their credit.

This brings us right back to that great debate: Should we invest in actively-managed funds or simply trust indexers with our money? As things stand, the indexing landscape is not quite cheery. We know we have talked about this earlier, but the point needs to be reiterated.

Besides the lone Benchmark MF, there is no specialist index chaser in this country. The index products that do exist are still rather small in size, lending credence to the belief that fund houses do not push them vigorously. Distributors too are perhaps not ready to tell their clients about the uses of these funds.

At another level, the milieu for index enthusiasts is limited. Few index fund providers have looked beyond the Nifty or the Sensex. No one offers a fund that mirrors indices like the BSE 200. (In other words, there is no equivalent in India of players that seek to replicate the popular S&P 500 index.)

All in all, the investment community seems to focus solely on active management and the ability of active managers to surpass the returns generated by the broad market (as represented by indices).

In fact, as some sections will no doubt underline, active managers have indeed done better over stretches of time.

Such sections will also refer to the performance numbers pertaining to three- and five-year periods. As reported by Value Research, active, diversified funds turned in 35.22 per cent, compared to 29.68 per cent by index funds over 3 years (as on March 29). The two segments delivered 38.59 per cent and 28.56 per cent respectively over 5 years.

However, there is this clever quote (you are listening to John Bogle, founder of Vanguard) that one may use to counter the argument. Here goes: "The all-market index fund and the Standard & Poor's 500 Index Fund are far better ways to invest than searching through a seemingly-endless list of the products of the marketing-driven, asset-gathering machine that today's mutual fund industry has become."

There is, of course, a very good way of working around this debate. It is simple - just suggest to investors that they need to do both. That is, put in a part of their surplus in active managers. The rest can go to the passive ones.

That suggestion, as you may have very well guessed, is inherently flawed, though. That is because it will simply lead to a bigger contention - how exactly should we allocate to the two? Should it be a 50:50 split? Or should we put, say, the bulk of our surplus in the index trackers, leaving only a fraction for the other lot?

These are extremely relevant questions, ones that only you can answer. After all, it is your money that is at stake here. And in your attempt to find the right answer, do remember the Warren Buffet quote. The legendary investor does have a point to make.

Feedback may be sent to nilanjan@thehindu.co.in

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