If one were to look at the chart of the Nifty and the Sensex below over the last 1 year, it is quite evident that the index has delivered phenomenal returns. It is not often that you see the Nifty and the Sensex giving returns of 28% annualized. That would lead us to the normal conclusion that an investor would have been better off investing passively than investing actively. Take a look at the chart below. If you would have just taken your money and put it in any index fund, you would have earned around 28% returns. Considering that the 10-year G-Sec pays a yield of around 7.33%, this equity return covers your market risk and still leaves a substantial return on the table for you. That brings us to a few very interesting questions.
Firstly, where should one stand in the passive vs active investor debate, especially in the light of the performance of the indices in the calendar year 2017. After all, the year began in the aftermath of demonetization but gave big returns on the back of the Trump trade. Despite the hiccups of GST implementation, the indices have delivered great returns. Would passive investment in 2017 have been a good idea? Looking ahead, what are the pros and cons of passive investing for the Indian investors at large?
To get a perspective, let us compare with other investment themes..
To get a clearer perspective of the active versus passive investing debate, one needs to look at how other active approaches to investing would have worked. While investing strategies would differ, a good approximation would be the way specific sectoral and thematic funds would have performed during the same period. Since there are a large number of funds in each of these categories, we have taken the median returns over the last 1 year of the top performing funds. That evens out the outliers and gives a good approximation of how specific sectoral and thematic funds would have performed.
Source: Bloomberg & Value Research
Let us look at the last two indices of the Nifty and the Sensex. While the Nifty has returned 28.08%, the Sensex has returned 27.63% during the last one year. For a moment let us also factor in the argument of total returns and add the dividend yield. That will at best take the index returns 1.5% higher. Let us look at the two categories of fund performance comparison.
If you look at the sectoral funds, most of the frontline sectors like Banking, FMCG and Infrastructure have beaten the Nifty and the Sensex by a large margin. That means there has been sufficient scope for stock selection and alpha generation in these sectoral themes. The picture changes drastically when one considers pharma and IT related funds but that was always to be expected. These 2 sectors are more US centric and are undergoing larger structural problems. Unless an investor is too adventurous they would have normally avoid taking sectoral bets on pharma and IT.
Leave out sectors; let us now look at themes..
For a moment let us accept the sectoral downside argument that IT and pharma have underperformed. Let us smoothen these rough sides by considering funds based on market capitalization. As the above chart clearly depicts, both the large cap fund median returns and the mid-cap fund median returns are substantially better than the Nifty and the Sensex at large. Assuming that both these large cap and mid cap funds have an exposure to IT and pharma, it underscores that there is still room for alpha in the Indian markets and one can still earn attractive returns by buying good quality diversified equity funds. You can certainly beat the Nifty and the Sensex by a margin.
How should investors look back at 2017; better active or better passive?
Would investors have been better off adopting a passive approach in 2017? The answer is a clear no! While the index has surely given very attractive returns, there has been substantial outperformance by the equity funds across multi-cap themes and sectoral themes. Let us not forget that in a year when the Nifty scaled 10,500 and the Sensex scaled 34,000, there have also been 10-baggers and 15-baggers in the market. India has never been a passive investor’s market and 2017 just goes to reinforce that there is still room for active stock selection in the Indian context! The message is quite clear. In year 2017, active investing would have surely worked and outperformed your passive index approach. A wide choice of stocks and fairly predictable stories make the Indian market a stock-pickers delight. You surely want to make the best of this via active investing!