Indexing: Good, bad or ugly?

Well there is no Vanguard with 0.030% annual charges offering you an index fund. Well, at least not yet. When that happens there might be more indexing in India. Right now indexing is only at the periphery except for some NPS money and a few path breakers who are inexing.

Right now in India indexing is more a fad that a movement. So most of the arguments that I HAVE AGAINST indexing in this article may or may not be applicable to Indian conditions till say 2028 when Indexing may be a rage.

Parag Parikh used to be a big opponent of index funds and I remember he had some good solid valid arguments against indexing. I do not index myself, but recommend it as a nice solution to those who want to invest ‘directly’ without putting effort in learning how funds work. It is really a fill it, fit it, forget it kinda product.

  1. Indexing boosts the price of a share – just because a company has been included in the index – boosts the share price. This is because the indexers have to buy the share as a part of their mandate. So in this time of ‘mechanical’ investing suddenly funds get allocated to this company. For e.g. if BSE or NSE decide that they should have an airline in the index, or a life insurance company, or a general insurance company, it is fair that Indigo, Icici Prudential life, and Icici Lombard will get a leg up in their share price – fundamentals be damned.
  2. I do not like the distance in the decision making gap: As an investor in the index YOU are mandating the fund manager to buy shares in companies that are in the index. You do not seem to mind whether it is a good company, has corporate governance or no, is environmental friendly – all this is ignored. This means the shareholder’s importance is going down. I do not like this.
  3. The most valued company has the greatest weight in the index so it gets the highest money allotted to it. So if Reliance is the most expensive company it will keep getting more company, and keeping its weight the highest. If Hdfc bank is overpriced, it will continue to remain over priced because the really serious money gets indexed, and not actively managed. This is because every new rupee goes EXACTLY where the previous rupee went.

Who will do mindless equity allocation to Index funds? Obviously EPFO, NPS, Pension funds for a start. Soon some more ETFs will be created – psu etf, bank etf, metal etf…and people not capable of managing their own money will ‘pick’ etf. This is akin to PMS. Some of these unthinking ‘portfolio allocators’ will skew the market. That is scary.

There are more ill effects of indexing especially in India. I am not sure about how scientific is the construction of the index, we do not have real broad indices which people follow. Also I would like NPS not to have too much discretion (right now it does active investing) – I would like if the mandate said clearly ‘bse 200’ or ‘bse 500’ – I guess these more or less cover the full market cap of BSE. This will reduce ‘manager discretion’ ….

CAVEAT: I do not index, but have invested some money in an index fund…but that is not really significant…

 

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2 Responses to “Indexing: Good, bad or ugly?”

  1. The current annual management charges even for a fund with AUM exceeding 2 billion is close to 2%.

    High expense ratios and struggle to generate consistent and significant alpha surely drive a segment of investors or a part of investment towards index funds sooner rather than later.

    I only hope these index funds have extremely low expense ratios like 0.05-0.10% and mimic Total price indices closely.

  2. I have a query regarding index funds.. what happens to the dividend received from the shares ?
    Does it get reinvested or goes to the managers kitty ?
    If it gets reinvested, then how sure are we that returns from such ETF would give TRI based returns ?

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