Have the risk appetite? Bet on active funds

Conservative investors or newcomers can take passive route in mid- and small-cap categories

The new fund offer of Nippon India Nifty Smallcap 250 Index Fund is underway, and six index funds and exchange-traded funds (ETFS) are now available in the mid- and the small-cap segment. Many financial advisors recommend that investors have some exposure to passive funds in the l arge- cap segment, but a similar consensus does not exist on mid- and small-caps.

With passive funds, investors are assured of market-equivalent return. The SPIVA India scorecard for end2019 (the latest) shows that about 41 per cent of mid- and small-cap funds failed to beat the benchmark over a five -year period. Proponents of passive funds say even though the majority of active funds in these categories outperformed, there is no guarantee that the fund you choose will do so (it could be among the underperformers). Predicting which active funds will outperform over the long-term is i mpossible. “The funds that outperform may be different from the ones that have outperformed in t he past,” says Pratik Oswal, head of passive funds, Motilal Oswal Asset Management.

Conservative investors who aim to earn marketequivalent returns may opt for a passive f und. “By selecting a passive fund, you remove the non-systematic risks like stockpicking and f und manager selection,” says Vishal Jain, headETF, Nippon Life India Asset Management. The passive investor does not need to keep switching because of performance deterioration. “You can stick to the same fund or ETF for 20 years or longer and benefit from the India growth story,” says Jain. Newcomers who find it difficult to select the right active fund can also take this route.

Active fund managers say their track record speaks for itself. “The data shows that over 90 per cent of mid- cap active funds and approximately 80 per cent of small- cap active funds have beaten their benchmarks over the past five years. It would be premature at present to look at passive funds in the mid- and the small- cap category,” says Vinit Sambre, head of equities, DSP Mutual Fund.

These two categories are riskier. “Studies have shown t here is a four-five times higher probability of a mid- cap stock becoming a small- cap stock than of a mid- cap becoming a mega-cap. There are potentially more losers than winners in these categories,” says Sambre. He feels investors should go with a fund manager who has demonstrated the ability to eliminate the losers.

Fewer analysts track mid- and small-cap stocks. “Information asymmetry still exists in these segments, which active managers can take advantage of. Use active funds in these categories until that changes,” says Vishal Dhawan, chief financial planner, Planahead Wealth Advisors.

Mid- and small-cap passive funds have existed for a short period. “Adequate record does not exist to demonstrate that passive fund managers can run funds with low tracking errors, especially i n the small- cap segment,” says Dhawan. Fund managers are confident they can handle this issue. “The illiquid stocks have a small weight in the index,” says Oswal.

Investors with adequate risk appetite may stick to active funds. Conservative ones may take t he passive route.