Plan Ahead Financial Solutions (India)

7G10, Wing 7B, Juhu Sangeeta Apts. Juhu Road. Mumbai 400 049. Phone: 91-22-3296 5933 / 022 26611730, Email: contact@planaheadindia.com

INDEX FUNDS : HAS THEIR TIME COME?

The debate between active fund management and passive fund management has been on for some time now with the believers of an index strategy both in India and internationally strongly recommending low cost index funds, whilst money managers have waxed eloquent about their stock picking abilities and their ability to beat the indices. We felt that this may be an appropriate time to share with you our findings on the use of index funds in a portfolio, considering that we seem to currently be in the midst of a very sharp contraction of stock prices. What are Index Funds? An Index Fund is a mutual fund or an exchange traded fund that mirrors its portfolio to that of a particular index such as Sensex, Nifty, etc. The stocks are in the same proportion as the underlying index. For example, in an index fund that tracks the Sensex, the funds portfolio will constitute all the 30 Sensex stocks in exactly the same weights as is held in the Sensex. There is no decision to be made on what companies must be held, for how long and how much must be invested in each of them. Since the fund managers only aim is to capture the index return, his fund will mirror the index constituents exactly. He would keep the funds trading to the minimum level needed to accurately track the index. This is contrary to active management where the fund manager employs a wide array of stock selection techniques, intensive research, sector picking and market timing to try and beat the respective indices. Index funds work best in efficient markets (i.e. markets where it is impossible for investors to gain above normal returns because all relevant information that may affect the stocks price is already incorporated within its price) However, analysis show that Index funds have started to act as a hedge in falling Indian markets. Active Funds -35.94 Index Funds -35.24 Out Performance by Active Funds -0.7

Returns Time Frame Average 6 months Return

Average 1 Year Return

-7.96

-10.7

2.75

Average 2 Year Return

12.86

9.6

3.26

Average 3 Year Return

24.08

19.33

4.75

Average 5 Year Return

34.32

25.83

8.49

contd.

Plan Ahead Financial Solutions (India)

7G10, Wing 7B, Juhu Sangeeta Apts. Juhu Road. Mumbai 400 049. Phone: 91-22-3296 5933 / 022 26611730, Email: contact@planaheadindia.com

INDEX FUNDS : HAS THEIR TIME COME?

The above table analyses the average returns of active funds (diversified large cap funds) over the Index funds over different time frames. The statistics favour active funds over the index funds on a longer term horizon, but on a shorter term horizon the index funds have outperformed the active funds. Indian markets have gone through regular bear phases, the predominant one being the aftermath of the tech boom. This bear phase typically lasted for 1.5 years stretching from February 2000 to September 2001. A close look on the performances of the actively managed funds and the index funds in this period throws the following outlook:
Returns from 11.02.2000 to 21.09.2001 (Bear Phase) Absolute Returns (%)

BSE SENSEX

-56.18%

Average Active funds return (Net of Expenses)

-56.86%

Average Index funds returns (Net of Expenses)

-55.11%

Average Out performance by Index Funds

1.75%

The index funds had out performed the active funds on an absolute return basis by 1.75%. In other words, the index funds acts as a tool to cut loses on the down side during bearish phases. This drives home the point that index funds tends to perform better than most of the actively managed funds in bearish phases. Though the actively managed funds are an essential for growth and capital appreciation of assets, investors should start considering the index funds as an option to diversify their portfolio. A good way to build a smart portfolio would be to blend active and passive stock investments. Index funds can therefore be allocated a small proportion of the overall Portfolio.

Disclaimer: This document and the information contained therein is strictly confidential and meant exclusively for the selected recipient and may not be copied or modified or transmitted without the consent of Plan Ahead Financial Solutions. This report is for information purposes only and nothing should be construed to be of any investment advice. Please read the offer document for more detailed information on the scheme and risks before investing.