Active Vs Passive Funds

With efficiency coming into the markets‚ creating alpha over a long run is going to get tougher. Alpha creation means generating more returns than the benchmark indices.

Globally, across developed markets, the Exchange traded funds which simply follow the index have gained lot of popularity. Presently, Passive Funds (ETFs/Index Funds) are having 48 percent market share and are expected to cross 50 percent in 2019 in US Markets(Combined Debt and Equity). The major reason behind the aforesaid is the lack of consistency from active mutual funds and lower expenses that we have observed globally during downturn or in panics the active funds underperforming active Funds.

In India, because of the lack of efficiency, active funds have had a very good show since last couple of decades, but with the regulator SEBI getting more active, the last couple of years have been a roller coaster ride for the active fund managers. Only a handful of them were able to beat the index but with reclassification of stocks coming into picture, it is going to be tougher in coming weeks and months for the active funds to beat low expense passive funds.

As an active advisor, I feel that by investing into passive funds the investors will save themselves from idiosyncratic risk (Unsystematic risk), the one generating from timing into the markets and higher expense ratios.

Nipun Madan, CFA