Dampening the index fund craze

Recently, two index funds by SBI, the SBI Nifty 50 ETF and the SBI S&P BSE Sensex ETF, have gained massive popularity and accumulated impressive AUM (assets under management).

The primary reason behind the significant growth in their AUMs of Rs 1.5 lakh crore, and approximately Rs 1 lakh crore, respectively, is the influx of the Employees' Provident Fund Organisation (EPFO) inflows.

The popularity of index funds

Historically, the surge in popularity of index funds can be traced back to the influence of investment luminaries, John Bogle and Warren Buffett.

They praised these funds' simplicity, efficiency, and low cost, albeit with some riders.

This sentiment was echoed by the investing public, who quickly gravitated towards these funds, enamoured by the promise of low expenses and broad market exposure.

Active funds are no less

However, when we look at actively managed funds, we see that many of them have shown stellar performance, often outpacing their benchmark indices.

To illustrate, consider that out of 24 active large-cap funds, an impressive 20 have outperformed the S&P BSE 100 Total Returns Index (TRI) on a 10-year rolling basis, since 2010. To clarify, we compared the average returns and not how often the funds beat the benchmark.

This statistic is compelling enough to make us pause and wonder if the index fund frenzy is really justified.

The risks of index funds

Additionally, index funds aren't without risks as well.

By their very design, index funds track the market. In times of market turbulence, this can lead to significant investment losses. The 2008 financial crisis and the 2020 COVID pandemic are stark reminders of this reality. The index funds plunged alongside the market, leaving investors with substantial wealth loss.

Conversely, actively managed funds, guided by seasoned fund managers, have offered an efficient safety net in such turbulent times. For instance, about 69 per cent of the active large-cap funds performed better compared to S&P BSE 100 Total Returns Index (TRI) in 2008.

Final thoughts

Considering the diversification they can provide, it may still be prudent for investors to allocate a small part of their assets to index funds in their portfolio.

Having 1-2 index funds with exposure to the broad equity market can provide long-term benefits.

That said, don't allocate more than 10 per cent of your money to these funds.

Suggested read: How to choose an index fund?