There has been a raging debate about active versus passive funds for many years.
John Bogle, the father of index investing, has popularized the concept of passive funds. His idea was simple – most active funds underperform the index in the USA after costs (including taxes) and therefore one should invest in low-cost funds that mimic holdings of an index.
These passive funds are also traded on stock exchanges and are known as exchange-traded funds (ETFs).
The concept has caught attention around the world due to the underperformance of many large-cap mutual funds. In India, index funds investing is also becoming popular.
However, I am not convinced and do not recommend index funds to our clients for investments in India. We being a fee-only SEBI RIA, are agnostic about active or passive funds. Our only objective is to recommend what is best for the clients.
Here are two strong reasons for not recommending passive funds over active funds:
1. Scheme Selection: Passive funds make sense for the allocation in the large-cap category because 60% of active large-cap funds have underperformed the index in the last 10 years. However, we have been able to continuously select the other 40% of outperforming large-cap funds for our clients. Therefore, generating higher returns than Nifty in the large-cap allocation.
2. Period Selection Bias: The period to evaluate passive funds performance vs active funds has been 10 years which coincides with a strong bull market phase. There has been no painful bear market to witness, barring a short blip after covid lockdown. Once we have gone through a bear market and evaluated the performance of passive funds vs active funds, then only we can convincingly say which category is the winner. If passive funds do better than active funds in a bear market as well, I will be happy to allocate investments in them. Till that time, the jury is out.
My strong suggestion is not to invest in any scheme or category just because it’s getting popular. Most of the time, in investments, popular ideas end up giving poor returns or costing you lost opportunities.
Originally posted on LinkedIn: www.linkedin.com/sumitduseja
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