Index Fund Investing: Commonsense Investing!

Markets: We are sick, need shock therapy.

Policy-makers: Sure! Will slash interest rates to zero and roll out economic stimulus packages.

Markets: Silly you, shock therapy to treat Corona NOT to hide your inefficiencies.  Even otherwise, this shock therapy has run its course already.

Policy-makers: Oh! It’s an out-of-syllabus question then…

Markets: No problem! Pay the price.

In summary, that’s been the ground reality nowadays. No vaccine for Corona yet, awareness has improved though. But the damage is already done. And now, the entire focus of almost all major economies has shifted from growth to damage control.

Market participants are busy drawing parallels between the crisis of 2008 and the current one—which is their pastime.

Investors’ response has been mixed—some are pessimistic to an extent where they swear they will stay out of markets for the rest of 2020, and others see the current market fall as a rare opportunity to cherry pick.

However, the majority of investors lie between these extremes.

If you

  • Are new to stock market investing
  • Have no time to do research yet want to reap benefits of investing in equities
  • Understand risks associated with equity assets
  • Have a 5 year plus time horizon

Then, investing in Index funds at this juncture is a no-brainer strategy for you.

What are index funds?

Index funds are passively managed mutual funds—meaning the fund manager doesn’t take active calls on companies, industry exposure and allocation between cash and equities. Instead, the fund simply mimics the underlying index in terms of composition of companies and proportions. For example, an index fund based on Nifty 50 will replicate the index constituents in its portfolio (in the same proportion as that in the index).

Why this strategy is likely to work in prevailing market conditions

Cherry picking in extreme bear markets requires you to disassociate yourself from the past glory of a stock and reassess its potential under the changing market conditions and the business environment.

For example, if somebody asked you to pick index heavy stocks in 2008, most of the investors would have picked companies such as Reliance, Larsen & Toubro, SBI and other infrastructure related companies, which had done exceedingly well between 2002-2008.  Picking, HDFC Bank, TCS, HUL would have required vision then, as these stocks were not in the limelight compared to their counterparts.

Fast forward 12 years: barring a few exceptions, today’s preferred index-heavy names aren’t the same as they were 10-12 years ago. And that’s why you should avoid betting on a specific company or a set of companies. When you buy an index, you are ruling out stock specific risks.

Buying a stock that has lost the most or one that has fallen the least isn’t a surefire strategy either, unless you know how strong the fundamentals of the company are under changing market conditions. For instance, from the beginning of 2020, Bharti Airtel has gained 57% and ONGC has lost 60%–which one will you buy? Or will you buy Index heavyweights such as HDFC Bank (-12% YTD) or TCS (-14% YTD)?

Index funds help avoid such difficult choices.  Buying small and midcap companies, though available at attractive valuations, is even more challenging.

Globally, index funds—Exchange Traded Funds (ETFs) and non-ETFs are getting immensely popular. They have continuously eaten up the market share of actively managed funds over the last 8-9 years.

Index Funds: gaining popularity…

Benefits of Index Funds

  • Simple and cost-effective way of investing in equity markets
  • Exposes you only to the systematic risks; i.e. company specific risks associated with active portfolio management are avoided automatically
  • They generate returns commensurate to that generated by the underlying index, after adjusting for expenses
  • The portfolio is automatically rebalanced as per the changes in the underlying index
  • Optimal diversification can be obtained by investing in index funds tracking different indices

Index funds aren’t as popular in India as they have been in developed countries. According to AMFI data, Index funds and other ETFs account for only 7% of the Industry AUM (Assets Under Management) of Rs 27.2 lakh crore.

Historically, Indian markets have generated 12%-15% annualized returns over longer time periods. This makes them an attractive choice.

Which index fund should you invest in?

At present, majority of 32 available index funds track Nifty 50 Index. However, the others follow, Nifty 100, Nifty Next 50, Nifty 500, Nifty SmallCap 250, Nifty Midcap 150 and Nifty Equal Weights. While you invest in Index Funds, please don’t ignore your financial objectives and overall asset allocation.

If the data do not prove that indexing wins, well, the data are wrong—John Bogle

You May Also Like to Read: What’s driving gold prices down in a time of crises?

 

Disclaimer:

We, Ventura Securities Ltd, (SEBI Registration Number INH000001634) its Analysts & Associates with regard to blog article hereby solemnly declare & disclose that:

We do not have any financial interest of any nature in the company. We do not individually or collectively hold 1% or more of the securities of the company. We do not have any other material conflict of interest in the company. We do not act as a market maker in securities of the company. We do not have any directorships or other material relationships with the company. We do not have any personal interests in the securities of the company. We do not have any past significant relationships with the company such as Investment Banking or other advisory assignments or intermediary relationships. We are not responsible for the risk associated with the investment/disinvestment decision made on the basis of this blog article.

One comment

Leave a Reply