Someone on Twitter mentioned that index funds create alpha. I don’t know how is that possible but what is certainly possible is that you can create investment alpha with your own behaviour.
It is a known fact that the returns of an investment instruments (say mutual fund) and the actual return of an investor vary significantly.
Why is that?
Who doesn’t know about HDFC Mid cap Opportunities fund? It is one of the star funds from the HDFC MF stable.
The fund started its journey in July 2007, almost at the height of the previous bull market. Its current fund managers are Chirag Setalvad and Rakesh Vyas.
The fund seems to have done really well. The regular plan of the fund boasts point to point returns of 28.63%, 20.95%, 26.26% and 17.82% for 1, 3, 5, and 10 years respectively. (see image below)
Compared to its benchmark, Nifty Free Float Midcap 100, the performance of which is 28.32%, 16.91%, 19.25% and 11.49% for the corresponding periods. The benchmark performance excludes dividends.
Even the expense ratio of the regular plan is one of the lowest in what most of its peers charge.
It has been an impressive streak of performance, no doubt.
Yet, every time an investor came asking for advice about this fund, I would say NO.
Why? Where’s the problem?
I made my first investment in mutual funds on Nov 5, 2004. It was a tax saving mutual fund.
Before that, I was investing in stocks too. I invested in a few including an IPO. But stock investing was too much to handle for me. Given my laziness I could never make the effort to build a decent stock portfolio. (Yes, I believe it takes work.) I sold the IPO soon after pocketing some nice listing gains.
Now, the next best option was investing through equity mutual funds. I invested these ready made stock portfolios managed by some of the best minds, read, fund managers.
It has been so far, so good.
However, for the last few weeks I have been thinking, in fact rethinking, my decision.
I have been evaluating the other side of mutual funds. Yes, they have a lot of good features but then every coin has two sides. Here is what is going on in my mind.
“I made a couple of amazing investments today”, announced Nikhil. His voice was brimming with excitement.
Nikhil and I had recently become friends.
“OK. And what are those?” I was curious.
“I have applied to this new fund offer of Select micro cap series N. The fund house is known for its stock picking skills in this category. In this new fund too, they will pick the best of the micro sized companies. In fact, the past returns of such offers has been in the 30s.”
It looks like Nikhil was sold big time on this new fund. He himself was sounding like a fund salesman. “Is this a closed ended fund, I mean is there a lock in?” I queried.
“Yes, 5 year lock-in. But that is OK. Micro caps need that much time.” This was further proof. The AMC should actually consider hiring him.
“Who told you about this fund?”
“My bank relationship manager.”
“Oh! so you bought it from the bank.”
This article assumes that you understand active vs passive funds. Click here to read the primer.
Index funds as well as ETFs or Exchange traded funds are very popular in US and Europe. So much so that Vanguard, the largest mutual fund company in the world, offers only ETFs.
ETFs follow a passive management style. They simply mimic the index in terms of its holdings and produce a similar return too. The cost of these funds is very less since there are no fund management charges or active trading involved.
Now, seeing the popularity of these funds, it comes as no surprise when the investor, more specifically, the NRI investor comes asking for ETFs and Index funds to invest in.
The reasoning is clear – beating an index consistently over a period of time is a difficult task. The investor is better off investing in an ETF based on an index thus save expenses and improve his returns.
Let’s test this hypothesis as of today.
“Vipin, I am planning to start investing in mutual funds. However, I do not want to go headlong into equity so will start with a balanced fund.”
OK. That sounds good. Balanced funds bring the best of both the worlds to you.
“Now, I was told about one of the most reputed funds – HDFC Prudence. But then I realise that HDFC has another fund – HDFC Balanced. I am confused.”
Why are you confused Vinay?
“Arre bhai! Which one should I invest in? And why are there 2 balanced funds in the same fund house?”
OK, lets begin from the start. What were you told about HDFC Prudence Fund?
“That it has a good track record. Also, that is managed by one Mr. Prashant Jain, who is supposedly one of the best fund managers.”
Hm, anything else?
“I also looked up the site which gives star ratings. It has got 4 stars.”
We both smiled.
“I know it doesn’t matter. OK, now you need to help me decide. Which one?”
Sure Vinay. Let’s get a better understanding of each of the funds. That would automatically bring out the difference between the two.
Hopefully, you will get to decide the right one for yourself.