Mirror the index, not the fund

If you do not want to be disappointed when the bull market resumes, it is best to switch to an index fund, which will ensure that you get market returns for a minuscule fee.

V.K. Sharma        Print Edition: November 27, 2008

V.K. Sharma
V.K. Sharma, Anagram Securities
Investors have made money in bull markets simply by following in the footsteps of their chosen fund managers. However, continuing to shadow your favourite fund manager may not be that bright an idea in a bear market. Take Reliance Industries. At the zenith of the bull market, the stock was trading at Rs 3,252. It tumbled 71% to a low of Rs 930 on 27 October 2007. By June 2008, it had become evident that the company’s gravitydefying gross refining margins (GRMs) were headed for the terra firma. When the going was good, no one questioned the disparity with the Singapore GRMs. When the company reported lower GRMs in September, investors began to look beyond the numbers and bailed out.

While the Tata group was the toast of the country when Tata Steel acquired Corus and Tata Motors bagged Jaguar and Land Rover from Ford, they happened close to the peak of the world economic cycle and were unfortunately funded by a generous dose of debt. Suzlon’s acquisition of RE power and Hindalco picking up Novelis were attempts by Indian corporates to leapfrog on to the world stage, but suffered from similar shortcomings.

The anecdotal evidences now emerging from these corporate stories are not very comforting and point to a larger malaise in the Indian economy. Reliance’s halving of its polypropylene capacity at Jamnagar is more of a comment on the state of the economy, as polypropylene is used extensively to make sacks for packaging commodities such as cement, food grains, chemicals and a host of automobile products. The curtailment of production of commercial vehicles by Tata Motors is again a critical indication of the broader economic slowdown.

The investors who have been in a buy-and-hold mode like their mentors have taken a beating and those who have shuffled portfolios have probably lost more than them. Even if you have been thorough with your research and have bought the same stock as your fund manager but at a fraction of the price, there is no guarantee that you would still have made money.

If you are trailing the steps of a smart fund manager, the chances of your making money in a bear market are remote because the fund manager will remain invested and be in cash only to the extent of the elbow room the offer document gives him. No fund manager would have the courage to write to his investors to withdraw the money because he sees the markets falling. Since he is not sitting on a huge mound of cash, you will end up in a deeper morass. The only advantage of continuously tracking the fund manager is that when the tide eventually turns, you would be generally fully invested. But still there is no guarantee that even if the Sensex recoups its high, your mirrored portfolio will also do so.

If you do not want to be disappointed when the bull market resumes, it is best to switch to an index fund. It will ensure that you get market returns for a minuscule fee. In an index fund, the fund manager does not have the freedom to choose his stocks, which reduces the management fee and chances of making mistakes. Though it compromises on the option of getting better returns than the market, it’s your only safe bet to recoup lost money in the long run. If the index rises, you are surely going to be in the winning team. Index funds may seem to be a dumb idea, but it is an idea whose time has come.

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