Index mutual funds (MFs) and exchange-traded funds (ETFs) are great products, at least in theory. But can the same be said on a practical level? Are there getting enough retail investors to invest in these funds? An index MF seeks to mirror a broad stock market index by investing in stocks that constitute that index in the same proportion as the weighting of specific stocks in that index. Given this, the returns on such funds are closer to the overall returns of the broad market index. Furthermore, ETF is an index fund which can be bought and sold on the stock exchange.
Total amount invested in index funds and equity ETFs, till January 4.3 trillion. The total amount invested in actively managed equity MFs was 15.1 trillion. Thus the amount invested in index funds and equity ETFs was 28.3% of the active funds. It sounds huge.
But a lot of the money invested in the four largest equity ETFs is institutional money coming from the Employees’ Provident Fund Organization (EPFO). After all, the money invested by EPFO is also retail money which is being invested in the index. But this is not an active choice being made by the retail investor.
Once we ignore the four largest equity ETFs, the total amount invested in other ETFs and index funds 1.3 trillion. This is around 8.4% of the amount invested in actively managed MFs and is a better representation of active choice. A disclaimer needs to be made here. Some retail money is invested in the four largest equity ETFs and some institutional money should be invested in other equity ETFs and index funds. There’s really no way to adjust for this.
Nonetheless, there are 202 other equity ETFs and index funds. Total investment of 196 funds out of these 5,000 crores. This implies that the huge amount invested in these funds is basically retail money.
Clearly, not enough retail money is invested in index funds and other equity ETFs. Why is that the case? One school of thought could possibly be that, in the Indian case, many actively managed equity MFs have outperformed a broad index such as the Nifty or the Sensex. This is true. However, there is a small problem with this argument. It has been made with the benefit of hindsight. As Eric Enger writes How economics can save the world: “After the fact, you can always identify individual stocks or funds that outperform the market and outperform the index. But before the fact, you cannot identify with confidence that it Which one is going to happen.” Clearly, most retail investors do not realize that such a risk exists.
In addition, what economists call availability bias is at work. When was the last time you saw a story in the media about someone who got rich investing in index funds? As Engner writes: “Stories about successful investment strategies are legion. You read them in the financial press and in business magazines, under titles like ‘How I Got Rich’ … I can’t remember ever meeting someone who did.” read a story about someone who made money investing in index funds.”
Furthermore, many investors seek excitement and meaning in their lives while investing. Index funds and ETFs are boring and may not deliver on those parameters.
Anyway, the fact that retail investors are bombarded with that kind of material leads to an availability bias. They see stories of people getting rich by investing directly in stocks, in actively managed MFs, in futures and options, in crypto and so on.
So, when it comes time to plan their own investment strategy, they invest in these things because it is the material available in their mind; The material on which they make their investment decisions.
The good news is that the proportion of money going into index funds and other equity ETFs has increased slightly over the years. As of March 2021, the total amount invested in other ETFs and index funds (adjusted for top 4 ETFs) was 50,560 crore or about 5.2% of the money invested in actively managed equity MFs at that point of time. Now, as mentioned earlier, it has crossed 8%. It is expected to go up further in the years to come.
Bad Money is written by Vivek Kaul.
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