Active versus Index Equity Investing - Early Evidence from India

Abstract

This paper examines the relative performance of actively managed equity mutual funds against liquid, low-cost index-tracking exchange-traded-funds in India and investigates the merit of investing in index trackers. This is an important discussion as a majority of flows to equity schemes in the Indian fund industry currently go to share classes of actively managed funds with the highest total expense ratios. This high expense ratio raises the question of whether an investor would be better off investing in a low-cost index tracker. To deal with the active-vs-index decision for an investor, we build a simple yet robust framework using Information Ratio and R-square and use this framework to examine the performance of key equity scheme categories against two index trackers in India. The paper preliminarily affirms that low-cost index ETFs in India are credible alternatives to actively managed funds both in terms of performance and cost to the investor. The results provide preliminary evidence of, broadly defined, closet indexing in the Indian active fund management industry and raises issues of reasonableness and relevance of choice of benchmarks by active fund managers specifically in fund categories like focused schemes.