Sorry Mr Buffett, your advice of index fund investing not best choice in India

Index-Fund

NEW DELHI: Berkshire Hathaway Chairman Warren Buffett, admired across the globe not only by the analyst community but also retail investors, said investors should “stick with low-cost index funds.”

This guru mantra might work for investors in the US or any other developed market, but may not be that effective in India, at least at the current stage of evolution of the Indian equity market, say market analysts.

Buffett, widely considered one of the world’s best equity investors, said in his annual letter to shareholders that trillions of dollars are managed by Wall Streeters charging high fees and it is best that large and small investors stick with low-cost index funds.

“Buffett’s quote is relevant in the US context, where majority of funds under perform the benchmark index. It is not relevant in the Indian context, where majority of funds outperform the equity benchmark,” Nilesh Shah, MD, Kotak AMC, told ETMarkets.com.

“However, his quote is an undeniable universal truth that cost is an important part of return on investment. If your cost is high, then returns will get diluted to that extent. Keep a watch on cost vis-à-vis return,” he said.

So, what is an index fund?

As the name suggests, it is a fund that invests in an index. In other words, the scheme will perform in tandem with the index. The management fee for index funds is less compared with that for managed funds.

“There is enough data to support that active fund managers have a role to play in emerging markets like India, which are not most efficient,” Nilesh Shetty, Associate Fund Manager for Equity at Quantum Mutual Fund, told ETMarkets.com.

“But yes, the cost of investments matters a lot. Over the long term, a high cost structure will most likely under perform the benchmark,” he said.

For example, the SBI Nifty Index Fund has an expense ratio of 0.70 per cent, whereas an actively-managed fund such as SBI Bluechip fund charges 1.98 per cent (as of January 31, 2017). UTI Nifty Index Fund has an expense ratio of 0.2 per cent.

When investing in an index fund, it is important to take into account the tracking error, which is nothing but the difference between the returns of the index fund and the benchmark index.

Some schemes fail to mimic returns given by the index, but that is one of the reasons why active fund managers play a key role in adjusting the portfolio to generate alpha for unit holders.

Smaller size of the Indian mutual fund industry vis-à-vis the equity market capitalisation and lower market efficiency relative to other developed markets seem to support alpha generation by Indian fund managers.

By Kshitij Anand

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