Monday, May 30, 2016

May 2016
Piquant Parade
Allianz decided to walk away from the alliance with Bajaj because Bajaj did not honour a contract that allowed the German firm to buy more stake in the joint ventures at a price decided upon about a decade and half ago. Bajaj cited a central bank rule that prescribes transfer of stake at market-determined price to reject Allianz's demand. According to local rules, a foreign insurer that exited India will have to wait for two years to form a new joint venture in the country. However, there is no bar on buying a stake in an existing company. Bajaj owns 74% of their two JVs, Bajaj Allianz Life Insurance and Bajaj Allianz General Insurance. Bajaj Life is valued around Rs 11,500 crore and the general insurance venture about Rs 9,200 crore. At this valuation, Bajaj may have to pay around Rs 5,500 crore to buy Allianz's 26% stake in the two joint ventures. As per a 2001 agreement, the German company has a call option to increase its stake in the life insurance joint venture to 74% from 26% at a pre-determined price if allowed under laws and subject to regulatory approvals. If the option is exercised by July 30, 2016, the pre-determined price will be Rs 5.42 per share, plus interest at 16 per cent per annum from July 31, 2001, to the date of payment. After 2016, Allianz would have to pay the market price. 
Regulatory Rigmarole 
Market regulator Securities and Exchange Board of India (SEBI) is considering doing away with the yearly investment limit of Rs 50,000 per fund house through the online route. In addition, KYC registration agencies (KRAs) are developing a system to accept applications online without the need of a PAN card. According to SEBI guidelines released two months ago, investors can fulfil KYC norms online by using their Aadhaar card only. But, the online KYC process at mutual fundhouses is still based on PAN card details. Five KRAs are registered with SEBI at present. Aadhaar as a proof of residence fulfils all KYC requirements that we normally have. Doing away with the limit for investment will ease entry of new investors to the sector and benefit all stakeholders. The issue assumes significance since the lower House (or Lok Sabha) of parliament had passed the Aadhaar (targeted delivery of financial and other subsidies, benefits, and services) Bill two months ago. The Bill is aimed at better targeting of subsidies and identifying a person receiving a subsidy or service. For online KYC through Aadhaar, the verification process is completed by entering a one-time password (OTP) received on the investor's mobile or e-mail address registered with UIDAI. There are two conditions for online KYC which is based on Aadhaar. One, the amount invested should not exceed Rs 50,000 per financial year per mutual fund. Two, the payment has to be through an electronic transfer from the investor's bank account. Those using the offline route for investments in mutual funds are required to submit documents other than Aadhaar, such as PAN card, for KYC. Investors have to submit their documents at a point of service, or KRA, and do an in-person verification as well. However, PAN is not required for systematic investment plans, or SIPs that do not exceed Rs 50,000 in a financial year (called micro-SIPs). In this case, a copy of Aadhaar card, voter ID or driving licence needs to be submitted and cross-checked with the originals. KYC procedures for the capital market have already been streamlined and a single KYC can be used by all financial intermediaries including brokers and mutual funds.
Amid growing concerns around high frequency trading (HFT) or algorithmic (algo) trading, SEBI said that new regulations to ensure level-playing field and fair access will take shape before the end of the year. HFT refers to the use of electronic systems that can potentially execute thousands of orders on the stock exchange in less than a second, which gives them an advantage over conventional traders. To create a level-playing field and to tackle market-wide concerns emerging from the algo-trading segment, SEBI has been in talks with external advisers before finalizing regulations. Internally, the market regulator is debating options such as introducing speed bumps, order randomization, order bunching of trades and limiting access to co-location facilities. In addition, regulatory penalties on dubious algo trades may also be revised upwards to deter market players from placing orders that are manipulative in nature. Firms that have a high order-to-trade ratio would also be penalised to deter players from canceling orders. A number of algo traders are market makers and therefore have a high order-to-trade ratio. An estimated 20-30% of HFT players are providing market making and tend to have high order-to-trade ratio. Penalizing them may not serve an adequate purpose. One way of ensuring a level-playing field would be to make co-location facilities accessible to all brokers. Co-location gives considerable advantage to brokers. Due to high costs involved, the small brokers are not able to access it. Co-location involves setting up servers on the exchange premises. This reduces the time it takes for an order to travel to the exchange, giving them a speed advantage over those who are located farther away. The share of HFT trading as a percentage of overall trading has been growing consistently. In 2011-12, HFT orders as a percentage of overall orders in the cash equity segment were at 65%. This has gone up to 94% in 2015-16. HFT turnover as a percentage of overall turnover in the cash equity segment has gone up from 25% to 42% over the same period. In the equity derivatives segment, the percentage of HFT orders has gone up from 78% to 98% between fiscal 2012 and fiscal 2016.
SEBI has extended the implementation date for providing additional information in scheme information document (SID)/key information memorandum (KIM) till June 30, 2016. According to SEBI’s March 18 circular, fund houses were supposed to disclose this additional information from May 1, 2016.  Besides, they are to have a dashboard on their website which provides information on the performance, scheme AUM, investment objective, expense ratio, portfolio details, and the scheme’s past performance. Here is the additional information which AMCs will start providing from June 30, 2016 which will be a part of SID/KIM: The tenure for which the fund manager has been managing the scheme, along with the name of the scheme’s fund manager, scheme’s portfolio holdings (top 10 holdings by issuer and fund allocation towards various sectors), along with a website link to obtain the scheme’s latest monthly portfolio holding. In case of FoF schemes, expense ratio of underlying scheme, scheme’s portfolio turnover ratio, the aggregate investment made by AMC’s board of directors, concerned scheme’s fund manager and other key managerial personnel, illustration of impact of expense ratio on scheme’s returns. In addition, the regulator has clarified that this information has to be provided for all open-ended and close- ended schemes.
After SEBI asked fund houses to disclose the commissions of distributors in absolute terms in account statements, Securities and Exchange Commission (SEC) has introduced a similar rule in USA. The SEC has approved the recommendations of its Investor Advisory Committee in which it has asked US AMCs to disclose fees in dollar terms while issuing account statements to investors. SEC has moved a step further of SEBI by asking US AMCs to disclose the complete break up expenses charged to investors in absolute terms. All types of investment costs, including costs for advice and services as well as costs for investment products, affect the total amount accumulated by an investor in a long term investment. Because of the important role mutual funds play as long-term investments for individual investors, however, and because costs can vary greatly from fund to fund, providing clear disclosure of mutual fund costs has long been a priority.The Investor Advisory Committee recommends that the commission explore ways to improve mutual fund cost disclosures. The goal should be to enhance investors’ understanding of the actual costs they bear when investing in mutual funds and the impact of those costs on total accumulations over the life of their investment. In the short term, the Committee believes the best way to make investors more conscious of costs is through standardized disclosure of actual dollar amount costs on customer account statements. In addition, as part of a longer term effort to improve disclosures, we encourage the Commission to explore ways to provide context for cost information in order to improve investor understanding of the impact of those costs.

Monday, May 23, 2016


May 2016

Investors pumped in a staggering Rs 1.7 lakh crore into various mutual fund schemes in April 2016 with liquid or money market segment contributing the most. In comparison, a total of Rs 1.10 lakh crore was invested in April 2015. Generally, liquid funds witness heavy outflow towards the end of March and the trend gets reversed in April as banks and corporates reinvest the surplus, which they had withdrawn to pay their financial and advance taxes. According to the data from the Association of Mutual Funds in India, investors poured in a net of Rs 1,70,161 crore in mutual fund schemes in April 2016 as against an outflow of Rs 73,113 crore in March 2016. The inflow was mainly driven by contribution from liquid funds or money market category. Besides, inflows have resumed in equity schemes on strong retail participation. Liquid or money market segment witnessed Rs 1.34 lakh crore being poured in during April 2016 while equity and equity- linked schemes saw net inflows of Rs 4,438 crore. In addition, net inflow in balanced funds stood at Rs 31,448 crore. Overall, the asset base of the country's fund houses surged to an all-time high of Rs 14.22 lakh crore in April 2016 from Rs 12.33 lakh crore at the end of March 2016.

Equity mutual funds witnessed an inflow of Rs 4,438 crore in April 2016, making it the highest in five months, primarily on account of strong retail participation. The inflow comes after seeing a pull out of Rs 1,370 crore from such funds in March 2016. Prior to that, moderation in inflow was seen in the preceding three months mainly due to volatile equity markets. Equity schemes received funds to the tune of Rs 3,644 crore, Rs 2,914 crore, and Rs 2,522 crore in December 2015, January 2016, and February 2016, respectively. According to the data from Association of Mutual Funds in India (AMFI), equity funds, which also include equity-linked saving schemes (ELSS) saw net inflow of Rs 4,438 crore last month. This was the highest net inflow since November 2015, when equity mutual funds witnessed an inflow of Rs 6,379 crore. The rise in inflow can be attributed to investment in systematic investment plans (SIPs) and strong participation from retail investors. 

Driven by addition in equity fund folios, mutual fund houses have registered a surge of more than 4 lakh investor accounts in April 2016, taking the total tally to 4.8 crore. This is on top of an addition of 59 lakh folios in 2015-16 and 22 lakh in 2014-15. In the last two years, investor accounts increased mainly due to robust contribution from smaller towns. Folios are numbers designated to individual investor accounts, though one investor can have multiple folios. According to the data from the Association of Mutual Funds in India (AMFI) on total investor accounts with 43 fund houses, the number of folios rose to 48,071,814 at the end of last month from 47,663,024 in March-end, a gain of of 4.09 lakh. Growing participation from retail investors, especially from smaller towns and huge inflows in equity schemes have helped in increasing the overall folio counts. The equity category witnessed an addition of nearly 1.6 lakh investor folios to 3.62 crore in the first month of the current fiscal. 

The average ticket size or the average asset size in equity funds was Rs. 1.10 lakh per folio in FY 2015-16, according to the latest AMFI data. Also, nearly 81% of the investor accounts are in equity oriented schemes. As compared to equity funds, the average ticket size in liquid and debt funds is higher as such funds are dominated by institutional investors. For instance, the average ticket size in liquid funds is Rs. 54.30 lakh and the ticket size in debt funds is Rs. 7.33 lakh. Institutional investors including FIIs have the largest ticket size at Rs. 9 crore per folio. Retail investors have an average ticket size of Rs. 60,750 per folio while HNIs held Rs. 20 lakh per folio. Individual investors, including HNIs, hold a sizeable portion of equity assets which is reflected by the number of folios held by them. More than 99% of equity folios are held by individual investors. According to AMFI, HNIs are those who invest Rs. 5 lakh or more. Apart from equity schemes, retail investors hold more than 90% of folios in other fund categories too. For instance, individual investors hold 98% folios in debt funds, 92% in liquid and money market schemes and 99% in ETFs and fund of funds. While retail investors hold a majority of folios across scheme categories, their contribution, in terms of AUM, is small in debt funds, liquid funds, and ETFs. Nevertheless, retail investors dominate the industry, in terms of number of folios held by them. Of the 4.58 crore investor accounts as on December 2015, 99% folios are held by retail investors while HNIs and institutional investors hold 18.04 lakh and 4.63 lakh folios respectively. In terms of categories, nearly 81% of the total 4.58 crore folios are in equity schemes, 17% in debt schemes and the remaining in liquid funds, ETFs, and fund of funds. A positive trend is that the count of investor folios is continuously rising since March 2014, largely on account of increase in retail folios in equity schemes. The total investor base of the industry has increased from 3.95 crore in March 2014 to 4.77 crore in March 2016. Thus, the industry’s investor base is close to reaching the 2010 peak of 4.80 crore. Thanks to healthy participation by retail investors through SIPs, the industry’s investor base will expand further from here.

Piquant Parade

L&T Finance Holdings is considering selling its stake to a foreign partner. The non-banking finance company (NBFC) arm of engineering giant Larsen & Toubro (L&T) is also not averse to exiting the business altogether. L&T Finance has begun the evaluation process and is looking at valuations between INR 1,000 crore and INR 1,300 crore. This would value L&T Mutual Fund at 4-5 per cent of its asset size, in line with some of the recent acquisitions in the domestic AMC space. The move is part of L&T Finance's ongoing restructuring process, aimed at improving return on equity (RoE) and focusing on core areas such as rural, housing, and wholesale lending. 
To be continued…

Monday, May 16, 2016

May 2016

There is a dearth of NFOs in the May 2016 NFONEST.

DSP Blackrock Dual Advantage Fund Series 45 – 38 months

Opens: May 3, 2016
Closes: May 16, 2016

DSP BlackRock Mutual Fund has introduced the DSP BlackRock Dual Advantage Fund-Series 45-38M, a close ended income fund. The investment objective of the fund is to generate returns and seek capital appreciation by investing in a portfolio of debt and money market securities. The fund also seeks to invest a portion of the portfolio in equity and equity related securities to achieve capital appreciation. As far as investments in debt and money market securities are concerned, the fund will invest only in securities which mature on or before the date of maturity of the fund. The fund’s performance will be benchmarked against CRISIL MIP Blended Index and its fund managers are Dhawal Dalal, and Vinit Sambre.

Edelweiss ETF – Nifty Quality 30

Opens: May 12, 2016
Closes: May 20, 2016

Edelweiss Mutual Fund has launched a new fund named as Edelweiss ETF - Nifty Quality 30, an open ended exchange traded fund. The index consists of 30 stocks selected on the basis of a quality score by India Index Services & Products Limited (IISL). The investment objective of the fund is to provide returns before expenses that closely correspond to the total returns of the Nifty Quality 30 Index subject to tracking errors. The fund would allocate 95%-100% of assets in stocks constituting Nifty Quality 30 Index with medium to high risk profile and invest up to 5% of assets in debt and money market instruments (with unexpired maturity not exceeding 91 days) and liquid schemes with low risk profile. The investment strategy adopted aims to cover companies, which have a financially strong track record, as evidenced through historical financial indicators such as return on equity, debt to equity, and average year-on-year growth in terms of profit after tax (PAT), over the past three years. Benchmark Index for the fund is Nifty Quality 30 Index. The fund managers are Bhavesh Jain and Kartik Soral (Co-fund manager).

UTI Capital Protection Oriented Fund – Series VII-V (1281 Days)

Opens: May 13, 2016
Closes: May 27, 2016

UTI Mutual Fund has launched a new fund named as UTI Capital Protection Oriented Fund - Series VII - V (1281 Days), a close ended capital protection oriented income fund. The duration of the fund is 1281 days from the date of allotment. The investment objective of the fund is to endeavour to protect the capital by investing in high quality fixed income securities as the primary objective and generate capital appreciation by investing in equity and equity related instruments as secondary objective. The fund shall invest 70-100% of assets in debt and money market instruments with low to medium risk profile and up to 30% in equity and equity related instruments with medium to high risk profile. Benchmark Index for the fund is CRISIL MIP Blended Index. The fund managers are Sunil Patil and Srivatsa.

Kotak Capital Protection Oriented Fund – Series 4

Opens: May 16, 2016
Closes: May 30, 2016

Kotak Mahindra Mutual Fund has launched the Kotak Capital Protection Oriented Fund - Series 4, a close ended income fund that matures 1102 days from the date of allotment. The investment objective of the fund is to seek capital protection by investing a portion of the portfolio in highest rated debt securities and money market instruments and also to provide capital appreciation by investing the balance in equity and equity related securities. The fund managers are Mr. Abhishek Bisen and Mr. Deepak Gupta. The fund is benchmarked against CRISIL Composite Bond Fund Index (80%) and CNX Nifty (20%)

TATA MF – Tata Small Cap Fund, Sundaram Hybrid Series R-T, Sundaram World Brand Fund –Series IV, and HDFC Dual Advantage Fund Series III are expected to be launched in the coming months.

Monday, May 09, 2016


May 2016
At Berkshire Hathaway’s Annual General Meeting last week, Warren Buffett said that investors can make good returns by investing in index funds, which are passive funds. Citing the example of Vanguard Group index fund that tracks the S&P 500 index of large American companies, Buffett said that passive, unmanaged or ‘no energy’ investments can do just as well, or better, than ‘hyperactive’ investments handled by managers who charge high fees. Does this principle of making good returns from passive index funds or Exchange Traded Funds hold good in the Indian markets too? Can Indian investors follow this investment philosophy of Buffett? Not entirely. The big difference is that in the USA most indices are available to investors. But India is still more of an emerging equity market, where new companies are still being discovered and are yet to be listed or become part of the index. Because we have so much scope of investing outside of indices, investors are able to make money by investing in actively managed funds.
In the Indian market any fund manager provides lot of alpha over the index. In the case of actively traded large-cap funds, the returns could be higher than the index by 200-300 basis points over a five year period. While in the case of mid-cap funds the returns could be even higher. That is why over the long-term actively managed funds will give better returns. The biggest advantage of index funds is the low cost. The expense ratio of most index funds is less than 1. Another advantage of index funds is the low volatility. In the longer run, active funds do give higher returns because of the exposure to mid-cap stocks and mix of stocks. However, investors in index funds can enhance their returns by investing more when the indices are trading lower, say 11 or 12 Price/Earnings ratio and exit when the indices gain. According to data from Value Research, five-year returns from the top five large cap equity funds have been in the range of 8.18 to 12.26%. While the returns for index funds have been in the range of 6.37 to 7.16%.
The sparkling GEMs among the index funds in India in 2015 have retained their preeminent status in 2016 also.
Goldman Sachs Nifty ETS Fund Gem
Launched in December 2001, Goldman Sachs Nifty ETS Fund, the first ETF in India, has an AUM of Rs 965 crore. It is an Exchange Traded Fund which is listed on the capital market (rolling settlement) segment of the NSE. The fund aims to provide returns close to the total return of stocks as represented by Nifty 50 Index. Large caps rule the roost with 98.67% of the portfolio in large cap stocks. 99.64% of the assets are in equities. 58.84% of the assets are in the top three sectors, finance, technology, and energy. The one-year return of the fund is -6.17%, trailing the category average of -2.83%. The returns of the fund are benchmarked against the Nifty 50 Index. The expense ratio of the fund is 0.49% and the portfolio turnover ratio is 130%. The fund is managed by Payal Kaipunjal since May 2014.

ICICI Prudential Index Fund Gem 
The AUM of ICICI Prudential Index Fund, launched in February 2002, which has been hovering around Rs 91 crore last year, has reached Rs 199 crore at present. The fund aims to closely track the performance of Nifty 50 Index by investing in almost all the stocks and in approximately the same weightage that they represent in the index. Large caps constitute 98.6% of the portfolio, with 99.1% of the assets in equity. The top three sectors, finance, technology, and energy, account for 58.23% of the portfolio. The one-year return of the fund is -3.83%, less than the category average of 2.83%. The returns of the fund are benchmarked against the Nifty 50. The expense ratio of the fund is 0.79% and the portfolio turnover ratio is 8%. The fund is managed by Kayzad Eghlim since August 2009.

Franklin India Index Fund Gem
The AUM of Franklin India Index Fund, launched in August 2000, is Rs 213 crores. This open ended index linked growth fund, with the objective to invest in companies whose securities are included in the Nifty and subject to tracking errors, endeavours to attain results commensurate with Nifty 50 Index. Large caps constitute 99.15% of the portfolio, with 96.54% of the assets in equity. The top three sectors, finance, technology, and energy account for 58.5% of the portfolio. The one-year return of the fund is -3.97%, as against the category average of -2.83%. The returns of the fund are benchmarked against the Nifty 50. The expense ratio of the fund is 1.06% and the portfolio turnover ratio is 9%. The fund is managed by Varun Sharma since November 2015.

Principal Index Fund Gem
Launched in June 1999, the AUM of Principal Index Fund is Rs. 25 crores. The fund can invest up to 100% in Nifty stocks, and can take up to 10% exposure in money market securities. Large caps constitute 99.17% of the portfolio, with 97.28% of the assets in equity. The top three sectors, finance, technology, and energy account for 59.06% of the portfolio. The one-year return of the fund is -4.14%, as against the category average of -2.83%. The returns of the fund are benchmarked against the Nifty 50. The expense ratio of the fund is 1% and the portfolio turnover ratio is 31%. The fund is managed by Rajat Jain since August 2015.

HDFC Index Sensex Plus Fund Gem
Launched in July 2002, HDFC Index Sensex Plus Fund sports an AUM of Rs 117 crore. The fund aims to invest 80 to 90% of its assets in the companies that form the Sensex and between 10 and 20% of the assets in the companies which are not included in the Sensex. This fund has always had a large-cap tilt with 92.19% in large caps and 99.85% in equity. The one-year return of the fund is -5.56% as against the category average of -2.83%. The top three sectors of the fund are finance, technology, and energy. 56.56% of the assets are in the top three sectors. The fund is benchmarked against the S & P BSE Sensex. The expense ratio of the fund is 1.08% and the portfolio turnover ratio is 14%. The fund is managed by Krishan Kumar Daga since October 2015.

UTI Nifty Index Fund Gem
The AUM of UTI Nifty Index Fund is Rs 366 crores. This open-ended passive fund was created by merging UTI Sunder and UTI Master Index fund on March 14, 2012. This fund has the objective of investing in securities of companies comprising of the Nifty 50 in the same weightage as they have in Nifty 50. The fund strives to minimise performance difference with Nifty 50 by keeping the tracking error to the minimum. Large caps constitute 98.65% of the portfolio, with 100% of the assets in equity. The top three sectors, finance, technology, and energy account for 60.759% of the portfolio. The one-year return of the fund is -3.65%, as against the category average of -2.83%. The returns of the fund are benchmarked against Nifty 50. The expense ratio of the fund is 0.19% and the portfolio turnover ratio is 77%. The fund is managed by Kaushik Basu since July 2011.

Tata Index Nifty Fund Gem
Launched in February 2003, the AUM of Tata Index Nifty Fund is Rs 9 crores. The fund aims to provide medium to long term capital gains, by investing in equity shares of only those companies comprised in the Nifty 50 Index and in the same proportion as that of the index, regardless of their investment merit. Large caps constitute 98.53% of the portfolio, with 99.15% of the assets in equity. The top three sectors, finance, technology, and energy, account for 58.20% of the portfolio. The one-year return of the fund is -4.19% as against the category average of -2.83%. The returns of the fund are benchmarked against Nifty 50. The portfolio turnover ratio is 16%. The fund is managed by Sonam Udasi since April 2016.

Monday, May 02, 2016


May 2016

The curious case of Index funds 
The concept of index funds has not worked in India, at least not so far. They are a tremendous success in countries like the USA but not in India. Vanguard in the USA, the largest mutual fund company, has all its products as index funds. Less than 1% of the overall investments in equity mutual funds in India are in index funds. That says it all. The one word that would come to anybody’s mind who is picking mutual funds is ‘performance‘, which again, for index funds, is nothing to write home about. There are several ‘other funds’ that have delivered much better returns. And is that not what we want – more returns? The ‘other funds ‘are the ‘actively managed’ funds compared to the ‘passively managed’ index funds.
If you are new to the jargon, an actively managed fund is the one where the fund manager takes call on what should enter the portfolio, how much, and when. The fund managers call the shots based on several parameters that they have outlined as a part of the investing process. In contrast, a passively managed fund does not need a fund manager. Not literally. Someone does need to take care of the investor’s money. The difference lies in the fact that an index fund simply invests its money in a pre-identified portfolio of stocks. This pre-identified portfolio is usually a popular market index, say for instance, Sensex, Nifty, etc. Sensex, for example, consists of 30 large stocks that are listed on the Bombay Stock Exchange (BSE). Nifty is a collection of 50 such stocks that are listed on the National Stock Exchange (NSE). The 30 of the Sensex or the 50 of the Nifty also have predetermined allocations for each of the stocks. These allocations change over time as markets grow, companies grow – that is a different story though.
An index fund has a simple job 
Just take a look at what the stocks and their respective proportion in the market index are. Invest the money in exactly the same stocks and in exactly the same proportion. After that it has to ensure that the stocks and the proportion remain in tandem with the index. If the proportions change – the fund manager shuffles the portfolio to reflect the new ones. Unlike active fund management, there is no research involved and no extra effort in figuring out which stocks to buy, at what price and when. The success of the index fund is measured in how close it is able to replicate the performance of the underlying index it is copying. This is termed the tracking error. The lower the tracking error, the better the fund is. On the other hand, the active fund’s job is a tough one. It has to beat the underlying benchmark returns. After all that is what you expect, right? Take for example, Franklin India Bluechip Fund. The fund benchmarks itself against the BSE Sensex. The fund will work to deliver a performance better than the BSE Sensex. Hence, it will carry out necessary research and analysis, create investment strategies and decide which stocks and companies make the best investment opportunities. Is it not the precise reason you prefer investing in an active fund like that? Else, you are just better off investing in an index fund.
Is the performance remarkable in any way at all?

There are a variety of benchmarks that the funds use. From the popular ones like BSE Sensex and NSE Nifty to CNX 500 (HDFC Equity), S&P BSE 200 (Birla SL Frontline Equity), CNX Midcap, and S&P BSE 100, though Nifty seems to be a favourite among the funds. In terms of returns, active funds beat their respective benchmarks – that too by quite a margin. On returns basis again, the actively managed funds beat the index funds from the same fund house. The active strategy has emerged a clear winner. All index funds or passively managed funds have a very low expense ratio compared to their actively managed counterparts. It ranges from 0.3% to 1.05%. The low expense ratio is a result of savings on costs of research, analysis and frequent trading of stocks. The turnover ratio of the index funds too is much lower than the active funds, except in some cases. The need to change stocks frequently is just not there and that explains a lower turnover. Whatever one may say, when you select funds, it is the performance that you accord top priority.
Index funds in the context of India
In the Indian market scenario index funds may not be the best option. The basic principle of indexing is - the more the number of stocks comprising an index the better is the diversification and price discovery. Indian indices like the Sensex (30) and the Nifty (50) cover a relatively small number of stocks and ignore many opportunities in the mid-cap sector. Also, unlike the capital markets in developed countries, Indian markets have not been thoroughly researched and there is enormous scope to beat the market by sound research. 
The reasons that make index funds popular in the US may not entirely hold good in India for the following reasons: 
One, the Indian markets lack depth and are not as evolved as the US markets. Hence, there are plenty of opportunities outside of the index that an actively managed fund can tap, as the index does not capture the broad market too well.
Two, the tracking error (and therefore, expenses) in the Indian context is higher as a result of poorly constructed indices and the difficulty involved in tracking them.
Three, the choice of indices is mostly restricted to Nifty and Sensex here. We do not have the variety of indices that US offers.
Four, index funds work well if markets are efficient. Since all information that may affect a stock’s price is already factored in its price, you have very little scope to gain beyond that. However, in the Indian context, there is a larger group of stocks, especially in the mid and small-cap segment, that see constant re-rating and price discoveries as information is not free flowing.
Five, the index stocks picked here have liquidity as a major consideration and therefore, some very fundamentally sound companies may be left out of the index for this reason.
The proof of this is reflected by way of performance of index funds in India when compared with actively managed funds. Over a 5-year period for instance, more than two-thirds of diversified equity funds with a 5-year record comfortably beat the average return of index funds (19.5% compounded annually).
Do index funds make sense?
This does not mean that you should not go for index funds. A good index fund may form part of your core portfolio, along with a few active equity funds with a consistent record (than a flashy one) built around that, based on your requirement and risk appetite.The management of such schemes is easier. No decision is needed on what stocks must be held, for how long, and how much must be invested in each. The fund manager just needs to keep the trading to the tiny level needed to accurately track the index. 
The logical fallout is on cost. Since no research is needed, there is no need for costly analysts. No brainstorming on investment strategy is required either. This translates into low management fees and such funds have low transaction costs. After all, the fund manager will not be actively churning his portfolio. It is buy-and-hold in the true sense. 
So, it is obvious that an index fund can never beat the index. Neither should it do worse. This is contrary to active management, where the fund manager will employ a variety of techniques based on research, sector picking, and market timing to try and beat the market. 
A fund manager brings with him a lot of experience and follows a structured investment approach. He analyses companies, meets managements regularly and based on real-time developments and trend analysis, he can take decisions that help a fund outperform. According to financial planners, actively managed funds have performed better than index funds in the past and they expect that to continue in the near future. A fund manager has the freedom to limit the downside by holding only performing securities, or going into cash if the need warrants. In case of index funds, they fall with the markets, since they have to stay invested in a non performing stock as well. 
However, there are some problems with the way some index funds are actually being run. Some Indian index funds’ performance in the past deviates from the very index they are supposed to be based on. While a small mismatch, called tracking error, is normal, there are funds that have underperformed or outperformed their indices by several percentage points. For an index fund, doing better or worse than the index is definitely not a sign of good management.

Are investors doing the right thing by ignoring index funds?

While it is clear that actively managed funds have outperformed indices over the longer periods, the story is somewhat different over shorter periods. Why should the investor not take the cost advantage if the returns are not higher? In India, the expenses of index funds vary from 0.48% to 1.51% of the money managed. Market regulator Securities and Exchange Board of India has ruled that the maximum expenses charged by equity funds can be up to 2.5%, with the cap on index funds at 1.5%. 
Here are some cases against index funds and some in favour of them. 
Index funds tend to be popular in an efficient market. This theory holds that stock prices generally reflect all that is known about a company. Since the theory states that all markets are efficient, it is impossible for investors to gain above normal returns because all relevant information that may affect a stock’s price is already incorporated within its price. 
So, if all fund managers are investing in the same pool of stocks, it stands to reason that the average fund will do no better than the market’s average performance. By and large, this appears to be true for the US and Europe. Studies have shown that over any given period, a majority of actively managed US funds fail to beat the market. However, this does not appear to be the case in India. 
The move to a more efficient market would require a number of parameters being fulfilled, and they are time-consuming. Greater institutional participation would help the markets. Mutual funds still have a long way to go in adding depth to the market. The greater the participation of funds and wider the coverage, quicker the move towards efficiency. Until then, there will be enough opportunity for an active fund manager to tap and beat the indices. 
Foreign institutional investors have stormed the market over the past few years, but they cannot be considered stable, long-term players. As for the retail investor, he is not really long term and anyway constitutes a small percentage. 
A step towards greater efficiency would be more retail participation, either directly in the stock market or via mutual funds. So, until long-term institutional and retail participation increases tremendously, active fund management will stay crucial. 
At some periods in time, value investing, which involves scouting for cheap and out-of-favour stocks, works. And it is here that a good and active fund manager could bring returns exceeding any index. Indexing only makes sense in particular markets and it is most persuasive among large-cap stocks. 
So, does it mean if you want a portfolio of large-cap stocks you should look at an index fund? Not true. One argument always held in favour of index funds is that they own all the securities in an index, which is a fair and representative sample of the market. But this line of reasoning would hold if the index in question is a well-diversified one, which again may not be the case in India. 
Look at the Sensex—it may be a barometer of the market but it is not a guideline for investing. The Sensex is certainly not diversified enough to capture all sectors. Agriculture, tourism, shipping, aviation and textiles find no place in it. The same is the case with Nifty - shipping, aviation, textiles, consumer durables, agriculture, and tourism are some of the sectors that are missing.
Even if a sector is represented in the Sensex, the selection of stocks need not be the best investment. For instance, the “finance” component is limited to three banks and one financial institution. The financial institution is HDFC, but IDBI, IDFC and PFC are not present. Neither will you find Axis Bank Ltd, Kotak Mahindra Bank Ltd., or Yes Bank Ltd, nor will you come across broking stocks. 
Currently, most index funds track the Sensex or the Nifty, so investors are tied down to large-cap liquid stocks. Because of liquidity issues, a stock may find its way to the Sensex or Nifty, but that does not mean it is the best buy in its field. Smaller companies may provide better investment options. 
But, active fund management does not guarantee higher returns either. Such funds could fall heavily when the market tanks, but if you stay on for the long term in a good fund, you can beat the market. 
An argument in favour of index funds is that it is not easy identifying a good fund manager. And then there is a risk of the fund manager making some really bad calls, resulting in a dismal fund performance. 

There is nothing inherently good or bad about an index fund. But the very reasons that make index funds popular in the US would not hold in India. Consider an index fund if you want a broad exposure to the market, and that too in stocks with a large market value. But even in such a scenario, it would not be wise to put all your money into such a fund. A good way to incorporate a sensible portfolio would be to blend active and passive stock investments. You can take one index fund to form the core of your portfolio but allocate only a small portion of your overall portfolio to it. If its performance disappoints, replace it with another index fund. The balance “active” portion of your portfolio can be distributed in diversified equity funds. If you still have money to spare, you may consider a sector or thematic fund.