Index funds versus individual stock picking

“Where should I invest my hard-earned money?”

This question invariably puts investors into a serious dilemma as to which investment option should they consider. They get deeply consumed in the process of assessing, determining and considering options which would render optimal returns to them, involving minimal risk and offering safety to their capital.
Investment in equities (individual stock picking) and various types of mutual funds are two very obvious investment vehicles that would come to investors` mind. Equity funds, debt funds, balanced funds, index funds and so on are the several types of mutual funds, which can be considered. Which type of fund is better amongst them? The answer to this question would depend upon the investment goal, risk appetite and time horizon of the investor.
Let us compare individual stock picking and index funds in detail:
Individual stock picking is nothing but merely equity investing. It is the most popular investment vehicle amongst investors. It is considered a high risk- high returns investment vehicle.
But the Bear Market Run carrying on since last year has been responsible for the erosion of capital of several investors. On a broader side, the returns depend on the financial health of the company (of which you have purchased the shares), the performance of that particular sector and the overall market performance in general.
On a narrower side (investors' side), the returns depend on investors' investment objectives, risk taking capacity and tenure of the investment. If the particular sector or company's shares are not performing well, the investors incur losses. Risk of losing money is high in case of equities due to volatile nature of markets.
Index Funds are a category of mutual funds which invest into a whole index [Sensex (30), Nifty (50)] rather than a specific stock. This strategy is also called ‘indexing’. The goal of most index funds is to follow the index performance. Index funds buy all the stocks of a particular index. This is a passively managed scheme.
The fund managers of these schemes do not get involved actively in shares selection and the process of investing. However, the volatility of markets (indices) is uncertain. The performance of the indices cannot be foreseen by any one. In India, the indices (Sensex, Nifty) are small as compared to US index of S&P 500.
Benefits of index funds
Economical: Indexing is a passive investing strategy; it does not involve any active management by the fund managers as in the case of the actively traded funds. The main objective of index funds is to reflect the performance of indices. The cost of analysts` salaries, research cost, and brokerage is saved in case of the index funds.
Better Performance: The performance of passive funds is likely to be better than actively or professionally managed funds. In the long run, any particular stock cannot beat the whole index performance.
For the week ended Mar. 20, 2009, Index funds were the biggest gainers among all classes of mutual funds with 3.16% gain as the 30 share index, Sensex rose 210.07 points, or 2.40%, to 8,966.68 in the week ended Mar. 20, 2009. On the other hand, the broad based NSE Nifty rose 87.8 points, or 3.23%, to 2,807.05 in the same period.
NAVs of the index funds category gained 3.16% in the week Mar. 20, 2009.
Among the index funds, Nifty Junior BeES gained 4.33%, Benchmark S&P CNX 500 Fund added 3.49%, J M Nifty Plus Fund rose 3.33%, LICMF Index Fund - Nifty Plan climbed 3.27%, Birla Sun Life Index Fund gained 3.24%. (Myiris).
Diversified Portfolio: Index funds invest in all stocks from different companies and different sectors of a particular index, leading to a wide range of stocks, which helps in the diffusion of risk.
Returns: Returns in index funds are largely dependent on the performance of whole indices; the Sensex and Nifty being benchmarks of the index funds` performance in India.
Saves time and money: The hard core research of specific stock or sector is not required in case of index funds as these funds track the performance of whole indices and not a stock and sector in particular. This saves time and money also as nothing comes free and research is not an exception.
Disadvantages of index funds
Market risk: When the market undergoes a fall, you also lose in case of index funds as these funds are entirely based upon the ups and downs of the market
Less Flexibility: Index funds lack in flexibility, as investors don’t get the opportunity to invest into stocks in that particular index. This is so because there is no scope of selecting stocks of personal choice, based on quality and research.
Conclusion:
To conclude, index funds can possibly offer higher returns in the longer period of time, subject to performance of indices or markets. Index funds thus seem to be a better option between the two, as their advantages considerably outweigh the disadvantages. Diversification, lower cost and maintenance give them an edge over individual stock picking.
Source: http://in.reuters.com/article/personalFinance/idINIndia-38898620090406?sp=true

SBI gives top rate of 9.7 per cent among PF fund managers

State-owned lender State Bank of India has given a return of 9.7 per cent on provident fund deposits, which is over 50 basis above the top rate of 9.1 per cent offered by private sector provident fund managers for the quarter ended December 2008.
The other three fund mangers – all from the private sector - including Reliance AMC (9.1 per cent), ICICI Pru AMC (9.0 Per cent) and HSBC AMC (8.5 per cent) offered returns below the SBI's payout during the 17 September to 31 December 2008 period, an Employees' Provident Fund Organisation (EPFO) source said.
The EPFO, managing about 4.4 crore provident fund depositors, allowed the three private fund managers to manage its incremental deposits of about Rs25,000 crore per annum in July last year.
The aim was to improve the returns on EPFO's investments, which was earlier confined mostly to government securities and special deposit schemes.
The EPFO has invested Rs30,461 crore in central government securities, which earns a return of 7.25 per cent, and Rs20,000 crore in state government securities and loans, which fetches 7.5 per cent return.
Meanwhile, an advisory committee of the EPFO had, last month, rejected a finance ministry proposal to invest up to 15 per cent of its funds totaling around Rs1,82,000 crore in the stock markets. The rejection of a proposal to park this corpus amount in publically-listed companies and mutual funds for higher returns came in the wake of continuing volatility in the stock markets.

Source: http://www.domain-b.com/finance/banks/SBI/20090406_pf_fund.html

Future of MFs is in smaller cities: Birla MF CEO

Birla Sun Life Mutual Fund has retained its number 5 position among the top five fund houses, though its corpus declined by 3 per cent to Rs 47,096.23 crore as at end March. Birla MF is working on schemes that will act as a hedge to the market volatility and safeguard investors against capital erosion. ET spoke to Chief Executive Officer Anil Kumar to know more. Before shifting to Birla MF, Kumar was global head of Citibank’s NRI business last three years. He is an alumnus of IIM Ahmedabad and NIT Warangal.
Excerpts from the interview:
Q. What is your road map for the future in these troubled times?
A. We will continue our focus in launching innovative products capable of hedging against volatility in the market. We are looking at re-launching old schemes on similar lines, and are exploring the possibility of launching arbitrage and exchange traded funds.
We have consistent policy of declaring dividend in our schemes. Whenever we have surplus income, we will keep declaring dividend. Birla Sun Life Tax Relief ’96 declared 50 per cent dividend in 2008-09 despite these troubled market times. It was 200 per cent dividend in 2007-08.
Q. What do you give priority in running your AMC?
A. We give top priority to portfolio quality and security, size of fund corpus and ultimately our brand image. Identifying customer needs at the right time is a crucial aspect. Recession helped big fund houses to prove their worth in this respect.
Anticipating effects from the collapse of Lehman Brothers, we launched a short term debt fund that would invest in commercial deposits and commercial papers of PSU banks in the third week of September 2008. By October, it managed to raise Rs 3,800 crore from all classes of investors despite the economic turmoil.
Q. What prospects do you see for sustainability of the MF industry in India?
A. MF industry is in a “sweet spot” in India but it has a long way to go, as penetration is still very low. However, the market potential is huge. Only 5-6 per cent of household deposits in India find their way to MFs, which is lower than even the BRIC countries.
In the last five years, the industry has been growing at CAGR of 35 per cent. The future of the MF industry lies in Tier-II and Tier-III cities. The rate of deposits in these cities is proportionately higher, irrespective of market condition. Tapping this source will help MF grow manifold.
Further, opening up of the pension funds will help increase mutual funds reach. As a fund house, we will be looking at these new avenues to expand our product kitty.
Q. What are the product offerings you plan for smaller cities?
A. We are mostly promoting systematic investment plans through different equity schemes. We are also selling balance fund and debt schemes. We approach investors with two-pronged communication: 1) invest with 3-5 year time horizon 2) diversify your asset allocation with a mix of equity, balance and debt schemes.
Q. What sectors are you looking at for investment growth?
A. We look at sectors from a long term perspective. Infrastructure, FMCG and capital are three good sectors to look at. Realty, though currently going through a correction phase, has huge potential as there will be huge demand for housing in the long run due rising urban migration.
Q. Is the recently market rally indicative of a recovery?
A. It is difficult to take a definite call on this. Any negative global cue and uncertainty over general elections can play spoilsport. With sectors like steel, auto and cement showing signs of improvement, we however see revival/stability of economy by last quarter of the current calendar year.
Q. Can the MF industry, along with insurance companies, be an alternative to FII dominance in driving equity indices?
A. MFs and insurance companies are growing at a much faster pace. There is scope for further growth given the large untapped market space. During Q3 of FY 2008-09, MFs were sitting on cash of around Rs 15,000-20,000 crores. Had the same amount been invested in equities, it could have diluted FII impact. Larger participation by domestic institutions can definitely counter FII impact.

Source: http://economictimes.indiatimes.com/Future-of-MFs-is-in-smaller-cities-Birla-MF-CEO/articleshow/4366264.cms