To say that John C Bogle revolutionised investing for ordinary people would be an understatement. For years, stock markets were for the rich. By introducing index funds, Bogle bought stock markets to almost every American home.
Last week, he died at the age of 89. The Vanguard Group he founded manages assets close to a staggering $5 trillion dollars in assets. This is near twice the size of India’s economy.
Bogle leaves behind a legacy that is hard to ignore. He pioneered index investing at a time when fund managers commanded a premium to manage money. He ensured that you could put $10,000 into a Vanguard fund and pay merely $10 for fund management. This resulted in a substantial drop in fund management charges in the US. Warren Buffett, another legendary investor, endorses Bogle’s ideas of passive investing aggressively.
In India, the ever-rising mutual fund industry is bickering with stock market regulator Securities and Exchange Board of India (SEBI). While the industry wants to push active fund management to retail investors, SEBI is very keen that mutual funds bring down fund management fees that hover around 2 per cent of the assets under management. The regulator has called on mutual funds to promote index funds.
The battle really is about the business of mutual funds. Active fund management means your fund manager will work towards outperforming a benchmark index. Passive fund management means tracking the performance of the benchmark index. For example, if you invest Rs 10,000 in an active fund, your fund manager is supposed to outperform the mutual fund scheme’s benchmark like a BSE 200 or the Sensex. Doing better than the benchmark requires a capability to know better than the market. A fund manager must know when to buy or sell a stock in the portfolio. It involves picking stocks that would see gains better than the benchmark index consistently. It is easier said than done. Hence, the fund management cost of such funds is over 2 per cent of the assets.
Passive funds are index funds that do not have to do any stock picking. They have to allocate the money you invest in exactly the same proportion to underlying stocks as that of the benchmark index like the BSE 200 or the Sensex. Since it does not involve stock picking as index stocks and their weight in them is already decided, the fund management fees are low. They are below 1 per cent for most index funds.
Currently, diversified equity funds in India are generally doing well. Over the past 25 years, diversified equity funds have outperformed every other asset class like debt, gold and property by a significant margin. The Sensex has relatively given lower returns, but managed to comfortably stay over all other asset classes. If equity funds have returned over 18 per cent average return, Sensex has clocked higher than 14 per cent over 30 years. This is still higher than the average estimated 10 per cent return in other asset classes during that period.
For ordinary investors, diversified equity funds are relatively complicated to understand. Index funds are relatively easy to track and explain. Yet, a lot of investment goes in promoting diversified equity funds. This is because diversified equity funds can remunerate fund managers with a good fee. Index fund assets under management have to reach a significant level to really reward mutual fund companies and the massive distribution network. Hence, there is very little marketing budget allocated to them.
What you need to note
If you are a non-finance person looking to invest in equities, there is no better option than buying an index fund. That way, you can track the performance by merely tracking the performance of the benchmark index like Sensex or Nifty. Most mutual funds have index funds. It may be a good idea to directly buy them online. This is because mutual funds are unlikely to promote them against other active funds. A similar situation persisted in the US markets. John C Bogle, who initially followed the norms of the Wall Street, revolutionised fund management in the US. If American households are better off today than in the 70s or against those in any other country, there is a significant contribution to this disruption. In India, we are perhaps at the same stage. We need an entrepreneur with the same motivation of John C Bogle to cause the same disruption. In an era where everything is getting disrupted, this seems like a no-brainer
For ordinary investors, diversified equity funds are relatively complicated to understand. Index funds are relatively easy to track and explain. Yet, a lot of investment goes in promoting diversified equity funds. This is because diversified equity funds can remunerate fund managers with a good fee. Index fund assets under management have to reach a significant level to really reward mutual fund companies.