You just can’t beat the stock markets day in and day out

Index funds and their exchange traded counterparts, exchange traded funds (ETFs), have been extremely popular in the west. In India, they are just about taking off.

In the book ‘What Goes Up, The Uncensored History of Modern Wall Street’ written by Eric J Weiner, Jack Bogle, the founder of Vanguard Group, which launched the Vanguard 500, the first index mutual fund in the world, says: “The germ of the idea for index funds was in my 1951 thesis where I wrote that mutual funds can make no claims of superiority over the market averages”.

And that is an idea that Sanjiv Shah, executive director, Benchmark Asset Management Company Private (which has pioneered the concept of ETFs in India), seems to firmly believe in. In an interview to Vivek Kaul, Shah spoke on how he started believing in indexing as a concept and what makes him think that indexing through ETFs is the way to go in the days to come.

How did you start believing in the concept of indexing?
I was the head of desk of FIIs at DSPML, before I moved to debt and, more importantly, into derivatives. When you start doing derivatives you realise that markets are not just about the ability of fund managers to pick stocks. There are so many other factors that play in the market.

In derivatives one mistake can have costly implications. This got me to take a look at research available on efficient markets, as derivatives can only function well in a very efficient market, where the information available has been factored into the price and wherein you have lots of volumes. When efficient markets work, you just can’t beat the market on a consistent basis.

Can you elaborate on that?
Out of a hundred fund managers, two or three will spot inefficiencies and make money out of that. They will be heroes at that particular point of time, but can they do it over a period of time? More and more research shows that they cannot.

In the long run, because of the fact that markets are efficient on a mean reverting basis, you are always better off being in an index fund because the fund managers and others who play the stock market are going to make the market efficient.

And so that made you launch ETFs?
Well it was just not about indexing, we also had a view on distribution. If you look at the NSE infrastructure, you cannot beat it in terms of ability of people to buy and sell anywhere in the world. So how do you leverage that?, we asked. You need to be on the platform of the NSE.

That gave us the idea that we should do ETFs. Indexing is the investment philosophy, ETF is the distribution part.

Given this, why are index funds not popular? I guess it’s too early in the market. Also the distribution system in the country today doesn’t allow index funds to be sold more aggressively.

If I am an intermediary and you are an investor and I ask you to invest in a index fund, you’ll ask me why? But if I tell you a particular fund manager is good, you are more likely to invest in that fund.

If a guy who is selling a normal fund has to sell an index fund, there would be contradiction in what he is trying to sell. That’s why index funds have to be sold as a pull investment from an investor. In the US the VANGUARD funds starting becoming popular only in 1992-93. Even in the case of ETFs, the first one came in 1993, by such funds really took off only in 1998-99.

It takes time before people start asking for it. In US you have the concept of independent financial advisors (IFAs).

These are not transaction oriented guys. They take money from the investors and charge 1-2% for managing the funds. The transaction costs are reduced from the 1-2% charged. So, an IFA is essentially working for an investor. In India the more you get an investor to churn, the more money you make. But people are now talking about the churning in the industry being out of control. We believe the minute that is addressed index funds will start becoming more popular.