Santosh Joseph, Founder, Germinate WealthSolutions, a Bengaluru-based wealth management firm.

Questions asked by investors:
1. Are index funds a better option since they are low-cost?

2. Should we invest in ETFs?

3. Are mid and small cap index funds good for our portfolio?

His response to his clients:

Passive schemes are gaining traction after they proved their worth in the large cap segment in the last two years. We can debate about their long-term worth in the Indian market, but at the moment they are popular. The other reason for their popularity is their ‘low-cost’ structure. AMCs are also coming up with a lot of index funds and ETFs after they got acceptance in the market.

However, all this doesn’t make index funds the best investment option. Index or passive funds may or may not beat the actively-managed funds in the long-term. Investors who are investing via SIPs in actively managed funds shouldn’t stop their SIPs. If you have a big corpus and you want to invest in an index large cap fund, you can go ahead.

ETFs are immensely inconvenient for retail investors. Index funds are liquid and can be stopped and redeemed at will in case of any emergency. That is not true for ETFs. I would recommend investors not get lured by some ETF’s fancy returns and stick to basic index funds if they want to invest in passive schemes.

Mid and small cap segments in our market are not as polished as the international markets or the large cap segment. Small cap segment has companies which have governance issues and it is a large universe. Stock picking is the key for these two segments. There is a lot of opportunity to generate alpha in these segments. Hence, taking an index fund might kill your returns. Paying 1-2% expense for a constant outperformance over 10 years is really a great deal.

So, don’t fall for the ‘low-expense’ fad. Here’s a table of returns posted by indices v/s small cap schemes:

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