As financial markets mature and become efficient in terms of security pricing, generating alpha by active fund management becomes more and more difficult even for seasoned fund managers over the longer term.

A study spanning around 100 large-cap and mid-cap equity funds shows that in the last one year, only 39% of large-cap and 33% of mid-cap funds were able to outperform the NSE's nifty index.

Most academic and empirical studies have shown that asset allocation determines 90% of an individual's portfolio's performance and alpha generated by allocation to the better performing stocks/bonds/funds within an asset class determines only the remaining 10%.
Given all of the above findings, the recommendation to investors is to first chalk out a long-term strategic asset allocation plan based on one's risk profile and return objectives.
And then make lump sum and/or systematic investments in exchange traded funds (ETFs) — based on individual cash-flows — to achieve the desired allocation to various asset classes in the most cost- and time-efficient manner.

The ETF industry has also evolved rapidly in India with new products allowing investors to take cost-efficient exposure to 10-year Gsecs and US equity indices like Nasdaq over and above existing traditional products like gold and equity ETFs.

A common mistake many investors make is getting swayed by sentiments and over-allocating money to a single asset class at peak price/valuation assuming past returns shall continue to follow in future — most recent example being the case of gold in 2013 and equities in 2007-08 period.

Similarly, Indian investors have often ignored the potential of developed market equities as a source of diversification and a hedge to risk of rupee depreciation in light of high current account deficit.

Many global companies like Google, Starbucks, and Apple have delivered high double-digit earnings growth and stock performance over the last three-five years on the basis of their strong global franchise, high contribution of income from fast growing emerging markets and enviable competitive advantage(s) in the form of technology, brands and scale of operation.

One simple and efficient way for Indian investors to take exposure in such companies is to buy an Indian ETF tracking global indices.

In the last two years, the sensex has given a return of -1.7% per annum, while an Indian ETF tracking a global index has given a compounded return of 21.5% per annum.

Some key advantages of ETFs:

Low expense ratio: Annual total expense ratio of ~1% vs typical 2-2.5% for equity mutual funds.

Ease of purchase and sale: Can easily be bought/sold like any other stock on the exchange during trading hours without any paperwork, via any online/offline broker.

Happy Investing!!

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