Mutual funds aren’t hands off investments

The number of free resources which provide interesting and thought provoking view points is too many to count. Personally, I find myself spending a lot of time browsing sites (mostly written by bloggers in US) and trying to compare and contrast them with the data I have from India.

Just before writing this blog, I finally decided to check out the long pending list of podcasts I subscribe to but haven’t bothered in a while. First off the block was to check out the interview Barry Ritholtz had with Jack Bogle, the inventor of the Index Mutual Fund and Founder of Vanguard.

The interview lived up to the hype I had heard about it with some very interesting tit bits being revealed during the nearly two hour conversation. I do strongly suggest checking it out.

In India, neither ETF’s nor Index funds have taken off in a big way. While most Index funds suffer from pretty big tracking error, ETF is a product that nobody wants to sell – not your broker, not the mutual fund distributor and the way the biggest and well known fund has been changing hands, even the AUM doesn’t really want it.

The key reason many prefer Mutual Funds to ETF’s is that many funds have provided strong alpha (gains > Index) over the years and this has meant that many believe its far better to invest with a good fund than invest with something that will never out-perform the markets.

But as a recent Morning Star / Bloomberg post showed, his out-performance has come down a lot over the last decade though even now, funds exists that out perform the Index on a consistent basis. But the bigger question is, will we see similar out-performance in the future as well. Unfortunately, other than having a Almanac from the future, one is really clueless as to whether we shall continue to see this trend or shall we revert to what is seen in US where 90% of funds don’t beat the Indices.

Back in the 80’s, Hero Honda came out with a advertisement for its CD-100 with the tag line. Fill it-Shut it-Forget it. These days, Mutual Funds are said to be long term investments with a similar attitude necessary to build long term wealth. At the same time, I hear experts saying that one needs to monitor and if needed change the funds that one is invested in and for that you need to have a adviser who shall do the same for you (in return for a fee – either direct or in-direct).

For example, Manoj Nagpal  recently tweeted this picture of funds that needs to be reviewed if they were part of your portfolio

When advisers showcase how great fund performance of top funds have been over the last 10 / 15 years, the point they miss was whether they knew / willing to recommend the funds to their clients those many years ago. A few may have done, but that is always a probability when dealing with large numbers.

In stock markets, you see this behavior when people talk about how investing just 10K in the IPO of Infosys would have made them a Crorepati. What they miss is that very few people actually subscribed and while I don’t have data, very few would have remained invested through and through.

While there is a lot of discussion on the merits of investing in Mutual Funds, I am yet to hear of anyone say, invest in this fund for X years and there is greater than 95% probability that it will beat the Index over that period of time. The reason no one says that is that no one really has a clue as to what fund will be the performers over the next 10 years. Hindsight can only provide you with what worked earlier, no one really knows what will work in the future.

On one hand, we are told not to chase performance (a Vanguard Study if you are interested) yet, when advisers recommend you exit out of under-performing funds, that is exactly what they are doing. If you believe Active will out perform Passive in the long run, the best thing to do would be to stay invested while trying to see where you can cut costs.

Over the long term, what you pay can actually make a large difference in returns and a study by Vanguard claims that cheaper funds outperform expensive ones (Link to article). In the Indian context, we are yet to see any fund go below the 1% barrier when it comes to Actively managed funds with many happy to charge the maximum that is allowed which comes to around 2.5% if you go through a distributor. ‘

On the other hand, ETF’s like Goldman Sach’s Nifty Bees charge 0.50% and this difference can add up to a pretty penny over time, especially if one is looking at investing for the next 20 / 30 years. As Indian markets mature, we shall ape the behavior of markets such as US and that would mean longer periods of low returns. At those times, every Rupee saved is a Rupee earned.

In extreme long term, the choices we make with regard to the funds we invest have a large element of luck. Investors who invested in funds launched by companies such as Morgan Stanley / CRB / Taurus among others haven’t had that much of a great time while those who bet with Kothari (later Franklin) or ITC Threadneedle (later HDFC) saw better gains as fund managers were able to deliver more than what most other funds delivered. But who knew that back then?