Friday, September 5, 2008

Diversified Equity funds _ your Best BEt

Dear all,
" “..the best way to own common stocks in through an index fund..”
-Warren Buffett, 1997 (Berkshire Hathaway Inc. 1996 Shareholder Letter)""

When the World's richest investor says so, you have to accept without any second thought.
Index Funds, by definition, mirror the returns of the stock market (Sensex/Nifty,etc) they track. These funds typically invest in the index they track, in the same propotion and percentage in the stocks that the index has.

Index funds are perfect for the buy-and-hold investor - the kind of person who likes to sit back and let their investment grow, rather than moving in and out of the market in an effort to beat the market.

Index Funds are very popular in US and Europe. The trend is yet to catch up in India, mainly because some Index Funds have not only not able to match the Index returns but also lagged substantially in performance (ex. LICMF Index Plan).
Why is this so?.
This could be mainly because of the Tracking Error. The Fund Manager may not be track the stocks 100% as the Index has, leading to tracking error.

The obvious advantages of Index Funds are:
1. Index Funds Have Lower Fees
They should have lower fees simply the fund house do not have to hire costly Research Analysts to analyse stocks for them, the Index does it. And Being Passive, churning costs are down. These should typically lower costs to funds, which in turn passes to the investor.
2. Index Funds help you Achieve Diversification
The biggest benefit of investing in index funds is the fact that it helps in achieving diversification at no additional cost and time. The investor saves on the time and money required to do the research and analysis on selecting the stocks for a diversified portfolio. The diversification is achieved automatically as soon as the investor invests in an index which is nothing but a collection of diverse stocks.

The biggest disadvantage of Index Funds (especially in India) is that they tend to underperform the Markets and other Diversified Funds. Even though, research reports point out, that in US S&P 500 returns have beater 80% of Diversified Equity Funds, it is unthinkable in India, because of inefficient markets. Our indicies do not have the whole universe of Diversification. Even Real Estate was added to the Index only last year. At present, there is no place for Shipping, Textiles in the Index. So, in effect, Index Funds will not be able to invest in these sectors and many other sectors which do not have a place in Index and miss out on the opportunities available.

In fact, let me illustrate this with an example,.


Febraury 2000 December 2004
Sensex 5883 5961
Rel Growth 47.23 96.53
HDFC Prudence 22.30 52.16
HDFC Top 200 29.02 45.18
FT Prima 42.12 95.30
FT Bluechip 30.50 57.20
Rel Vision 29.88 72.61


So, the message is obvious.
If you had invested in Reliance Growth Fund in Feb 2000, when the Sensex was 5883, your value of money would have doubled in year 2004, though Sensex was nearly the same at that point of time.

The takeaway from the above illustration, is , Market Volatility should not be a concern for you, if have invested in the Right Fund.

And, another BIG lesson is, Don't try to time the market, invest in Diversified Equity Mutual funds.

Warren Buffet is not wrong. Obviously, the world's most successful investor can't be wrong. But in Indian context, his thoughts may not be relevant.

Of course, as an asset allocation, you should have an index fund, but don't have an over ownership of the same. Do invest across baskets and squeeze maximum returns on your investments.
Invest in the best Diversified Equity Funds and become a Passive Investor and see your money grow BIG.
Best of luck,

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