2G index funds are here

Western investors have been adherents of passive investing in a big way for quite some time now. Even their large institutions managing billions of dollars prefer index funds and exchange traded funds over actively-managed funds. Fund managers try to exploit pricing inefficiencies in order to outperform the markets. But as markets become more efficient (better researched so that fewer inefficiently priced stocks are available) it becomes harder for fund managers to beat the indexes. The higher costs of actively-managed funds compared to those of index funds and exchange traded funds also contribute to their underperformance vis-à-vis the latter. Another reason why investors prefer passive investing is that it is extremely difficult to predict in advance which actively-managed funds are likely to outperform their benchmarks over the next five, 10 or 20 years. In the light of these arguments, aspiring for average market returns (which is what an index fund or ETF promises) does not seem like a poor choice. In India passive funds have not caught on in a big way because many active funds still manage to outperform the indexes. But the margin of outperformance, according to experts, is beginning to narrow down. If the US precedence is anything to go by, it could lessen significantly in the years to come (in the US almost three-fourth actively-managed funds und

This article was originally published on August 13, 2010.