In an interaction with Anil Ghelani CFA, Head (Passive Investments & Products), DSP Mutual Fund

One mistake we make is to try and time the market

"One mistake we make is to try and time the market"
 

How do you differentiate between active and passive investment strategies and which do you think is better suited for the current market conditions?
 

While investing in an active strategy, you typically look at the investment framework of the fund manager and understand the style of investing. Similarly, since the base of your passive fund’s portfolio will come from the index that it is tracking, it is very important to understand the logic of that index and the selection and elimination criteria of stocks and risks involved in that strategy. In active strategies, the fund manager picks stocks based on their investment process and judgement of future prospects of the company, which would have human biases which are especially relevant in a very volatile and fast-changing macro environment.

Hence, in the current market conditions with expected volatility and uncertainty in global markets to continue, investors and advisors in the Large-Cap space should avoid complexity and keep it simple by investing in low cost, passively managed index funds. While some active funds with a robust investment framework could outperform the index, I recall here one of the learnings from John Bogle, the founder of one of the world’s largest mutual fund Vanguard, who said that while fund investors and evaluators think they can easily select the most superior fund managers, they are often wrong. If there are going to be only a few winners, it might be very difficult to identify funds which will outperform and then for those funds to continue such outperformance for a long period of time.
 

In recent times, diversification with commodity ETFs, such as gold and silver ETF, has gained significant importance among many investors. What is your perspective on this strategy?
 

Just like it is important to have a well-balanced diet for good nutrition, we should try to have a well-diversified investment portfolio with some gold and silver ETFs. This gives us an opportunity to hedge against a standard ‘equity-debt portfolio’ due to its low correlation with equity and often a negative correlation with debt as an asset class. Hence, exposure to gold or silver ETFs in your portfolio may make it a favourable diversifier, especially in troubled times. This component can also potentially act as leverage against the depreciating rupee. While it would be different for each person, I would broadly suggest seeking guidance from your trusted advisor and consider holding gold or silver ETFs in the range of 5-10 per cent of your portfolio.
 

Currently, ETFs and index funds have a very low penetration in the total mutual fund industry. What role do you believe passive investment strategies will play in the future of the financial industry, both in India and globally?
 

If we see the quarterly analysis of the industry published by AMFI, as at end of December 2022 we have 31,89,598 retail and HNI investor folios in index funds, which has grown manifold from just 426,589 three years ago. But this number is still very small in my view for a country with around 7 crore taxpayers. If we see the growth in the total mutual fund industry, we are still at a very low base relative to many other global markets. If we exclude a few large countries which have a mutual fund AUM to GDP ratio much above 100 per cent and just take a broad average, the ratio is around 75 per cent.
 

Currently in India we are only about 15 per cent. So there is huge scope for growth, both in terms of assets under management (AUM) as well as the number of people investing. This is where passive funds can assist in a big way to increase the penetration of new investors who have yet to start their investing journey. This is because they have relatively lower cost and are simpler so that investors can get a very clear understanding about their risk and return outcomes. Ultimately, investors get attracted for one of two reasons – to earn handsome returns and create wealth or invest in order to make available a corpus for future needs.
 

While globally we have already seen passive funds taking over in size, in India we are gradually seeing growth. In the last three years, equity index funds and ETFs got a higher net inflow compared to the active funds in the large-cap category and this trend is likely to continue. From the total mutual fund industry of about Rs 40 lakh crore, ETFs and index funds are now about 15 per cent of the total AUM. In my view, together with growth in the overall industry, we will see this proportion increase to 25 per cent by 2025. This is of course with the assumption that everything across the globe will remain normal unlike the pandemic that caused a major disruption.
 

What is your overall outlook of the market? Do investors need to carry some sort of caution with their investments under current market conditions?
 

Despite the recent correction in equity markets since the start of this year, the market is still not considered to be undervalued. The main caution in the current market condition would be to watch out for certain sectors which could be impacted by the side-effects of sharp interest rate hikes playing out and the second caution would be a slowdown in corporate earnings growth.