How will you benefit from investing early in mutual funds?

“One the most important and less spoken benefit of index funds is ease of asset allocation. It is really easy to allocate between different asset classes using passive funds, as they usually don’t drift from the mandate”:  Mahavir Kaswa, Vice President, Research (Passive Funds), Motilal Oswal Asset Management Company said in an interview with Money9.

Edited excerpts:

What are your views on the debate on benefits of investing in passive funds and active funds?

The active Vs passive style of investing is a really old debate.  Each style of investing has its pros and cons. However, one thing I strongly believe is that it is not correct to view them as ‘Active Vs Passive’. I believe that both strategies have a role in an investor’s portfolio.

Over the last few years, passive funds in India have emerged as a choice of investors. One of the primary reasons for this is the simplicity and transparency offered by passive funds. In addition, passive funds usually charge (Total Expense Ratio) much less as compared to their counterpart active funds.

Many investors (and advisors) while building portfolios, use passive funds for their core allocations, whereas active funds are used for satellite allocations. Over a long term this may prove to be a really effective strategy, as passive funds tend to help keep portfolio performance in line with the broad market, whereas satellite allocation to active funds tend to help investors earn little extra over broad benchmark.

Investors are warming up to index funds. What according to you are the benefits that these passive funds offer?

The response to index funds has been great, over the last couple of years Motilal Oswal Passive Funds has experienced great traction from investors. Our passive funds AUM grew multi-fold, where international funds were the leader in this growth.

One the most important and less spoken benefit of index funds is ease of asset allocation. It is really easy to allocate between different asset classes using passive funds, as they usually don’t drift from the mandate. For example if someone is looking for exposure to mid-caps, one can simply buy a midcap index fund, as per mandate, the fund will always stay invested in the underlying mid-cap index composition. This may not always hold true, in case of active midcap funds, where fund managers can invest in large-cap/small-cap stock up to 35% which is quite significant drift.

Raamdeo Agrawal of your group has recently said that Sensex might touch 2,00,000 in the next 10 years. How will this benefit index funds?

We are really excited with such a prediction. This is really great news for investors too. Someone looking to get benefit out of Sensex getting nearly 4x from current level, can simply invest in the index funds that tracks Sensex or Nifty-50 based Indices. Investing in index funds makes the job of tracking fund performance really easy for investors. Index funds have a mandate to replicate the performance of underlying index subject to tracking error.

Your fund house has two index focused products (Nasdaq 100 ETF and S&P 500 Index Fund). Why have two products focusing on American stocks? Do you have plans to go beyond US stocks especially at a time the world over emerging market stocks are being discussed?

Investing in international stocks is the key to diversification. Indian equities tend to have low correlation with international equities, especially developed economies. Motilal Oswal AMC has spent a lot of time and effort communicating this to the investors.

The US is approximately 55% of world total market cap and nearly 25% in terms of world GDP. With these numbers, I think it is quite logical to start with US markets when looking for international diversification. At Motilal Oswal AMC our effort is to offer investment solutions that are in the best interest of investors. We continuously keep looking to launch new and innovative products and emerging markets are one such opportunity that we are looking for quite seriously.

Small-cap funds have shown remarkable outperformance over large-cap funds in recent months. How should investors look at small-cap investments, especially in funds?

With multi-year underperformance to large-cap stocks, small-cap has exhibited impressive performance over the last one year. Small-cap stocks are usually a relatively less researched segment, and may potentially offer an opportunity for active stock picking; however we believe index funds still have an important role to play in the small-cap segment.

With a closer look at the active small-cap fund performance numbers, one thing stands out is lack of consistency of outperformance. In other words, small-cap schemes outperforming benchmarks keep changing. This becomes a task for investors to keep searching for a small-cap fund which may potentially outperform the small-cap benchmark. In addition, switching has cost and tax implications. There are investors who don’t want to keep shifting between the same categories of funds in chasing outperformers. I think small-cap index funds can be really handy for such investors, as they simply aim to replicate the performance of underlying benchmarks subject to tracking error.