Active Vs Passive Investing: Which Is Right For You? | NDTV Profit
Category
đź—ž
NewsTranscript
00:00Hello and welcome. You are watching the Mutual Fund Show. Now, the next 25 minutes we will
00:10try and explain to you what you should be doing as an investor who is looking to generate
00:14and create significant long term wealth. We often hear about the names like power of compounding,
00:20build a diversified portfolio, but the fact remains the starting point of all of this
00:25can be rather challenging if you are a new investor. Most new investors in the recent
00:30past have been lured by the returns equity markets have generated, but the fact remains
00:35that over a longer period of time, it's always good to have an expert help you in that. We
00:41have with us Shantanu Bhargava, Managing Director and Head of Discretionary Investment Services
00:46at Waterfield Advisors joining in. Hi Shantanu, thanks for taking the time to talk to us today.
00:51Shantanu, very happy to be here Sameena. Likewise, Shantanu, you know, the excitement
00:58and the euphoria around direct equity is notwithstanding. I mean, investors, traders have generated
01:06significant wealth, you know, simply by buying pretty much anything and everything in the
01:10markets over the last few years. But the fact remains and you would agree, you would agree
01:15with me on this, is that for long term serious wealth creation, consistent amount of consistently
01:22investing over a longer period of time is what would help you build a significant corpus.
01:27Now as investors and as the common man, we are told that in order to create this long
01:32term wealth, invest in mutual funds through SIPs, build a diversified portfolio. But the
01:38ideology that is told to us is that the way to do this is by plugging in products across
01:44the board, which may not be ideal, right? You want to go in and invest on a strategy
01:49and I know Waterfield does this really well. Elaborate and tell us why simply investing
01:53in products and plugging in products in a portfolio may not be the right way to do this.
01:58What you want to do is bet on a strategy and go all out. Sure. So let me take your first
02:05question first, which is the choice between direct equities and products. In the past
02:12four years, we've had a stellar run in markets and investors, especially first time investors,
02:18haven't experienced a deep correction. By deep correction, I mean fall of more than
02:2120% and we've had shallow falls and we've recouped very fast. So first up, we have seen
02:29a lot of investors putting money into direct equity. There's nothing wrong with it as long
02:34as one understands the business very well. So there's this classic question, you know,
02:39direct equity versus mutual funds. So there are two concerns there. First concern is that
02:44we have seen investors taking very concentrated bets on direct equities in stocks that they
02:50may not very well understand or they may not be tracking it. So there's a saying that I
02:55like that, you know, I will never own enough of any one thing to be able to make a killing
02:59in it. And I will never own enough of any one thing to be able to get killed by it.
03:05So large bets on a smaller number of equities certainly generate good returns and people
03:11have experienced it in the past. But holding many stocks more than simply holding a few
03:19is a better risk management strategy. So that's the first advice that one shouldn't be over
03:24concentrated. And second point is about consuming the information. So one thing that has dramatically
03:30changed in the past 15 years is that information is easily available. Why? As a firm, we actually
03:38encourage investors, especially first time investors to go with professional fund managers
03:43is because the ability of experts to actually separate noise from signals. So you and I
03:49both have the same information, but the way that information is processed and comprehended
03:55by an expert is very different. And they use it to that information to make active changes
03:59in the portfolio. So therefore, we firmly feel that at the center of the investment
04:06strategy, one should prioritize vehicles like mutual funds and then selectively in areas
04:12where one feels confident, they can also look at direct equities, but very, very selectively.
04:16Now how do you start your second question? So process starts with planning, which starts
04:20with clearly distinct objectives and constraints. So the first thing that we do when we work
04:26with clients is to determine what they're trying to accomplish and how much time they
04:30have to accomplish it. Understanding limitations is also important. What really gets glossed
04:36over is an investor's state in terms of knowledge and expertise. You know, a lot of times investors
04:44have just seen returns and they may not have seen deep down cycles in the market. So that's
04:50a very important consideration in terms of understanding and fully fleshing out the profile
04:54of the client in terms of their risk tolerance, ability, and also their knowledge and expertise.
05:01And then only we move on to the development of the strategy, which first starts with asset
05:05allocations. I'll quickly come to products, but we have all heard of the adage that don't
05:13keep all your eggs in one basket. So asset allocation is a smart form of diversification
05:18wherein you're actually spreading your investments across different types of assets, different
05:23asset types like stocks, bonds, gold, cash, and real estate. Why asset allocation? See,
05:29the thing is that theoretically, if you were to just allocate everything in equity and
05:33just hold that portfolio next 20 years, you will certainly make the best returns. But
05:37what hurts investors is price volatility. So given the option, you know, most of us
05:41would want to earn a good long-term rate of return with little or no price volatility.
05:46But in the real world, we must choose between low price volatility and low returns or high
05:50returns along with higher price volatility. By volatility, I mean the daily changes in
05:54the value of the portfolio, and that can actually unnerve a lot of investors. So what we have
05:59experienced in the past three decades is that the path of the portfolio returns also matters
06:06a lot. So asset allocation, along with diversification, is an attempt to make sure that the entire
06:12process of generating returns is more tolerable. And once we have, after understanding and
06:18comprehending what the trend is all about and understanding their investment objectives,
06:23we create an asset allocation strategy. Then we move on to the right security or instrument
06:28selection and diversifying, you know, across different types of products.
06:33You know, Shantanu, one key difference between a young retail investor versus families is
06:43that the very wealthy are trying to preserve their capital and they're comfortable beating
06:48inflation and creating a little bit of alpha over the nifty because a large chunk of that
06:53wealth is probably transitional in nature, right? Now, with the other type of investor
06:59who's looking to create wealth and build wealth, is the advice the same from you? Should both
07:04investors be as mindful of their objectives and be as risk-averse or risk-takers in that
07:11sense?
07:12That's a great question, Samina. See, principles do not change. It's important to think hard
07:19about protecting the downside because the mathematics of investing doesn't work in your
07:25favour. So if markets drop by 50% in a given year, then the markets have to bounce back
07:33by 100% just to get back to the previous value. So basically downside volatility hurts more
07:39than, you know, upside returns. So which is why irrespective of the segment, it's important
07:45for investors to think hard about protecting their downside and to prioritise risk management
07:53along with the return generation. So that does not change. The second thing is that
07:59especially in the case of first-time investors, it's important to think about the whole portfolio
08:05construction process in terms of different building blocks. See, one of the advantages
08:11that ultra-affluent have is that they have access to very high-quality advice which allows
08:19them to navigate difficult situations effectively, you know, because there are three parts to
08:26it. One is planning, then managing the portfolio and also maintaining the portfolio. Where
08:30I find a challenge when it comes to first-time investors is actually the third phase which
08:36is portfolio maintenance because if one does dabble into extremely high return generating
08:42ideas, it's very important to keep an eye on trends and make adjustments in the portfolio
08:48timely because what we've seen is that when people do get exposed to, let's say, thematic
08:53funds or sectoral funds, and we'll talk more about different types of vehicles, they get
08:59excited when the returns in the past have been really good. So they look at the rear-view
09:03mirror and make those allocations. So they enter and exit at the wrong time which leads
09:07to actually wealth destruction. So I would say that in absence of, especially DIY investors,
09:13if they don't have access to advisors or they don't deliberately want to engage an advisor,
09:19it's even more important to keep it simple and to focus on compounding rather than generating
09:24very high returns by getting into product ideas that they don't understand.
09:28Right, so now we luckily have access to you, right? So our viewers can of course have that
09:34access as we have this conversation. You're right, the very wealthy is an overbanked segment.
09:39Everybody wants to give them recommendations, tell them what to do. And let's not forget,
09:43they know how to make money. That's why they have gotten as wealthy, right?
09:46Absolutely.
09:47And the current situation at play right now, a lot of people are talking about how the
09:51markets are expensive, valuations are stretched. What should a DIY investor looking to do?
09:57Should they continue with their SIPs that they do? Should they sit on some cash? I mean,
10:02what is the advice that you give the very wealthy that, you know, a DIY investor can
10:06also benefit from?
10:08Sure. So first is the time horizon. So a lot of clients that we work with have ultra long-term
10:17horizons. They're thinking in decadal terms, 10 years plus. And I would think that that
10:22is the case with also first-time savers. They have 20, 30 years to go. So they shouldn't
10:29really worry about short-term blips in the market. And wealth creation and generation
10:36is a dual pursuit. One is to allocate in the right areas. It's also about investing regularly.
10:45So for sure, the practice of SIPs should be continued irrespective of what happens
10:50in the market. Corrections are part of investing. Actually, they should be perceived as an opportunity.
11:01But the regular investing program that an investor is following should not be cut short
11:05if there are falls in the market. And one should expect volatility once we've had, you
11:10know, three, four years of stellar run in the market. The lot that can happen can spook
11:14the market. But one should continue with their discipline investing regularly. To your question
11:19about cash, see, keeping 10 to 15 cash in the portfolio as an optionality never hurts.
11:25Once every 4 to 5 years, we get a chance to buy stocks at a discount, you know, when there's
11:30a fire sale. So actually, if we condition ourselves to perceive, you know, down markets
11:36or bear markets is actually an opportunity. One gets an opportunity to pick stocks at
11:40extremely attractive discounts that you generally don't find in Indian markets because Indian
11:45markets, because of the massive inflows and the stronger relative growth compared to other
11:49economies are generally slightly elevated in terms of valuations. So yes, please continue
11:54with the regular SIPs. Don't be deterred if there is a fall in the markets. In fact, if
11:59you have cash double down and buy more equities, specializing is 10 years or more.
12:04Shantanu, I want to, one strategy or one advice that, you know, I know you use and talk about
12:10often, and I know it's not one size fits all. So I'm mindful of the fact that all the advice
12:16that you give out to clients or your families that you work with, or even retail investors
12:21is got to be subjective in nature. But what stood out for me is that very often we talk
12:27about, like I said, amalgamation of products, right? So you will see portfolios where you
12:30have a few large cap funds, you have mid cap funds, you have thematic funds, you have
12:35global funds. And I think, I think investors believe that the way to diversify is by adding
12:40more products, as opposed to diversifying at an asset level. But what you interestingly
12:46talk about and have done, and I've seen this is where you believe that the way to do this
12:50is, is based on strategy where you add passive investing, active investing, and build a concentrated
12:56portfolio as opposed to owning the market. Because if you own the market, you can outperform.
13:00You want to elaborate on the strategy, because this was a standard, not very often, do your
13:05advisors build a portfolio on types of styles of investing in that sense?
13:10Absolutely, Samina. So at a strategy level, first of all, take a step back. So we, we
13:16sincerely believe that a healthy combination of active and passive investing is necessary.
13:22Even though proponents of both strategies present very compelling arguments for selecting
13:26one over the other. So you generally get to hear active versus passive. I think it's
13:31an and, and it's important that a healthy combination is pursued. I'll just take a step
13:37back and talk about active and passive investing for the benefit of all your viewers. So first,
13:42let's talk about a benchmark index. So benchmark index is a collection of stocks or securities
13:47that shows how a given market or a segment of the market is performing. So for example,
13:52Nifty 50 index includes shares from companies ranked among the top 50 in terms of market
13:56capitalization in the country. And Nifty Midcap 150 includes shares from companies ranked among
14:01the top 150 in terms of Midcap market capitalization. Or in the case of bonds, let's also talk about
14:06bonds. We have indices like Nifty Bharat Bond Index that measures the performance of all AAA
14:12rated bonds issued by government owned entities. Now passive funds seek to replicate the performance
14:18of a specific index like Nifty 50 or Nifty Midcap 150. It's a fairly administrative work.
14:24They're just replicating the composition of the underlying benchmark to mirror the performance
14:29of the underlying benchmark. Active funds seek to outperform the benchmark index by making use of
14:35the skills of a professional fund manager. So such fund managers carry out active security
14:40selection and timing. And these decisions actually lead to a differentiated portfolio
14:46from the underlying benchmark. So here's how it works. So let's say HDFC Bank represents 11% weight
14:54in Nifty 50 and Axis Bank represents 3% weight in Nifty 50. Let's suppose we've got two managers.
15:01One manager is a large cap active manager and while the other one is a passive manager.
15:06So the active manager believes that from a three-year perspective, Axis Bank's prices
15:12will rise faster than HDFC. Based on his or her belief, the active fund manager overweights Axis Bank
15:17in the portfolio which is to say that against 3% index by 5% and underweights HDFC which is
15:24to have a slightly lower allocation compared to the index weight. Now if this active fund manager
15:28is right about both his overweight and underweight positions, this fund manager will generate
15:35outperformance versus Nifty 50 stocks. But if he's wrong, his portfolio will underperform. So that's
15:40the risk that you always face when you are allocating money into active funds. You may do
15:45better than the benchmark or underperform the benchmark. In the case of pure passives, the
15:49portfolio composition will be similar to the corresponding benchmark and there's no
15:54possibility of outperformance. So at a construction level, we think about different product categories
16:02like active funds, passive funds, thematic funds, sector funds as building blocks of an overall
16:11portfolio. And as a firm, we found the use of core and satellite method to diversify the portfolio
16:18very very helpful. So like you rightly said, one size doesn't fit all. So because one size never
16:26fits all, let's start with the core of the portfolio. This is very similar to building a
16:31house. So when you're building a house, the foundation of the house has to be very solid.
16:35So the core portfolio forms the base of a client's investment strategy and should provide stability
16:41and long-term growth potential. So the purpose of the core portfolio is to ensure that portfolio
16:45grows with the market trends at the least possible cost. Cost is an important consideration
16:51and without any mistakes. And the core part of the portfolio, in the case of a financial portfolio,
16:58should ideally comprise of traditional low-cost index funds and ETFs. That should form the base
17:04of an investor's portfolio and I'd say that it can be 30 to 40 percent of the overall portfolio.
17:09Then comes the satellite. Now in the satellite part, you've got a couple of building blocks.
17:16We have two types of active funds and I know there is always this question mark between mutual funds
17:21and PMS, so I'll cover both of them. Within active management, there are two options.
17:26There are active strategies that actually endeavor to deliver market-plus returns with
17:34market-like risk. So basically, they're not taking a lot of risk. They may be taking slightly lesser
17:39risk than the broader market, which is measured by different ratios like beta and etc. I'll not
17:46go there. But essentially, they're trying to beat the benchmark without really taking more risk than
17:52the benchmark. And their outcomes are slightly better than index funds with not a lot of risk.
17:59And this bucket is actually filled by diversified mutual funds. And within that, to complement the
18:06passive funds, one can look at flexi-cap funds or multi-cap funds because of the nimbleness.
18:10They can actually, depending on the way market valuations are in terms of large-cap, mid-cap
18:16stocks, segue between different market sectors and different market capitalizations and give a
18:22good return experience to clients without taking a lot of risk. Then comes the next active strategy
18:28where the primary objective is return maximization and the fund managers are actually taking a lot
18:35more risk than the underlying benchmark. And this bucket is actually filled by, on the mutual fund
18:40side, a category called focus mutual funds. And then, of course, the PMS products that
18:46concentrate portfolios and take a lot more risk than the underlying benchmark. So, I would feel
18:51for a first-time investor, it's important or someone who's started investing last 2-3 years
18:56to have the foundation fixed, to have 30-40% allocated into traditional low-cost passive funds
19:02and then add diversified mutual funds in the flexi and multi-cap side. And if one is
19:09experienced enough, if one has seen, let's say, 2-3 market cycles, if one has experienced the
19:13COVID fall and did not really exit the market, then one should consider dabbling into PMS
19:19products that are riskier, they take a lot more risk in the markets. There's another thought and
19:23I'd like to share that with you. Based on efficiency, the whole promise of active fund
19:29management is based on the concept of having some kind of advantage in terms of information.
19:34The top 100 or 120 stocks by market capitalization are so heavily tracked by analysts,
19:41by HNIs, by institutional investors that there's very little informational advantage to be had.
19:46So, actually, for an active fund manager in the large-cap space or a strategy which is
19:52large-cap leaning to generate outperformance compared to a benchmark consistently is going
19:58to be a challenge more and more and data proves it. Large-cap funds, 90% of them have not
20:02bet the benchmark in last 10 years. So, it means that if one is aiming for a 50-60% allocation
20:08into large-caps, it's better to build that allocation through low-cost ETFs and index funds.
20:15Whereas on the mid and small-cap side, where still there's enough information,
20:20inefficiency, the stocks are not that heavily tracked still, there are a lot of hard-working
20:27active fund managers who actually go to the companies and come back, do their primary research,
20:33do their channel checks and come back with information that an average investor may not have.
20:36So, on the mid and small-cap side, it does make sense to pay that higher cost and have
20:41allocation to actively manage PMSs and mutual funds. So, that's how we approach the whole
20:44construction process. But I would say that depending on a person's experience and overall
20:52risk profile, one should prioritize building the core of the portfolio first, which should
20:56be populated with index funds and ETFs, and to add diversified mutual funds in the multi-cap
21:02and flexi-cap category. And then after some time, once an investor has experienced enough volatility,
21:09one can really get into more aggressive strategies. There are two more building blocks,
21:12thematic and tactical, which we can take up. Right. So, Shantanu, just a couple of, we've got
21:17about five, six minutes. I'll do a quick rapid fire with you because that always seems to work
21:22so we can get maximum out of this conversation. Sure. Direct equity or mutual fund for long-term
21:26wealth creation? Mutual funds. Right. Which market cap is passive investing most suited
21:31for, large-cap, mid or small? Large-cap. ETFs, yes or no? Yes, 100 percent. ETFs or thematic
21:39or themes or sector-wise bets? If one is working with an advisor,
21:46for DIY investors, I will advise against dabbling into thematic and sector funds.
21:50What is the ideal number of products or mutual funds should one have in their portfolio,
21:54irrespective of the kind of wealth one has? Not more than seven to eight instruments.
22:00Across equity and debt, or would that just be equity?
22:03This is equity. So, equity portfolio can have between six to eight funds and a debt, of course,
22:10one will have four to five funds. So, equity in isolation, six to eight funds.
22:14For somebody who doesn't have access to an advisor, do you think a good way to do asset
22:18allocation could be through balanced funds or hybrid funds? Definitely. So, when I spoke about
22:24the core of the portfolio, for a balanced profile investor, that can actually form the foundation
22:30of the portfolio, a balanced advantage fund, but a true two-level balanced advantage fund.
22:35Within that also, one has to really do their research and figure out which one is actually
22:38following the whole asset allocation properly. How frequently do you recommend investors to
22:45review their portfolio? See, at least once a year, one should review their asset allocation. So, if
22:53because of market movement, there has been a drift in a particular asset class,
22:57then one should arrest it and bring the weight back to the target allocations of 50 equity,
23:0150 bonds portfolio, that's become 60-40 after a year, despite the element of taxation,
23:06one should bring it back to 50-50 if the drift is significant. If the drift is just a few
23:10percentage points, one should ignore. So, at least once a year. In terms of managers specifically,
23:14please be patient with mutual fund managers. Sometimes the underperformance is a result of
23:20a lot of factors which is beyond their control. And I would say that once a manager has been
23:25chosen, the manager should be given at least 12 quarters before the manager is fired from
23:28the portfolio. And how often should you look at making changes and what would be a red flag for
23:33an investor to go out and make changes, clearly not just underperformance, right? Absolutely.
23:38Those are more qualitative factors. So, what we do as a firm is we also track changes at an
23:44asset management firm level. So, if there are any integrity issues or if there are any compliance
23:50breaches, those are red flags and one should think hard about the AMC and the fund. Second,
23:57of course, is a lot depends in the case of active fund manager on the fund manager himself or
24:02herself. If there is a change in fund manager, then in the least, one should stop allocating
24:08more and take a pause and reassess whether they want to continue with the fund after giving it a
24:12couple of quarters. So, change in fund manager is a red flag in the case of active investing. And,
24:17of course, if there is any compliance breach or integrity-related issue,
24:20one needs to reassess allocation to that AMC. What is the word on gold? How significant or
24:25important is this in one's portfolio given the recent rally of costs? Very, very bullish in gold
24:33from a long-term perspective. Let me qualify long-term as five years or plus. With the way
24:38the structure is evolving globally, we feel that gold will continue to do well,
24:44especially in risk-off environments and come to the rescue of the portfolio and other
24:47asset class not working. So, despite the run-up that we have seen, we continue to be bullish in
24:52gold from a five-year-plus perspective. Shantanu, one skill that you think is
24:56most important for an investor to have in order to generate and create long-term wealth,
25:01what is your learning? I would say it is more of a trait, patience.
25:06Patience and faith in future and discipline. And how important is the cost of investing?
25:14Is that something investors should be mindful of or it is not too much of a concern
25:18for a retail DIY investor? See, one needs to be smart about it. So,
25:24like we discussed in areas where... So, one has to think in terms of the return on investment.
25:29So, in areas where the probability of cost getting rewarded is higher in terms of outperformance,
25:36one should be mindful but should be liberal. So, like in the case of small cap funds,
25:41if one is okay to allocate to active managers, one should go ahead and do it.
25:46In the case of, let's say, large cap funds where anyways the decks are stacked against
25:51the fund managers, it is better to save on cost and think about cost optimization.
25:56But one should keep an eye on overall portfolio level total expense ratio.
26:00With Nifty at 25,000, lump sum investing or SIP?
26:05I would say that if one comes into money, if there is a windfall, go ahead and allocate least
26:1025% to 30% immediately and the rest should be staggered over the course of next six months.
26:14And if one is continuing with their regular savings plan, one should anyways do that SIP,
26:21one should continue with SIPs. Right. Thanks, Shantanu. It is great talking
26:24to you today and help us build some perspective for our viewers. Thank you very much with that.
26:29Thank you, Samina. Thank you. With that, we are completely out
26:31of time. Stay with the channel, a lot more programming on the other side, so keep it with us.