When more people take to investing in mutual funds – or even worse – Index funds – what happens to the active investor? Does it get easier because there are are fewer players seeking alpha or does it become more difficult?

• first of all it is mythical to say that all index investors are passive investors,
• many index investors invest in other funds along with index funds – surprising but true
• if more people shift to SIP and indexation are less players playing the active investing?
• the question is difficult to answer in India because we do not have accurate data

Assuming that it is the active investor who is shifting to SIP in the index, clearly there are lesser players at the poker table now!! That means the active player has lesser opponents to play against, and that might making getting that alpha more difficult.

Even Warren Buffett will find it difficult to maintain the gap between him and the others. Take a game like cricket surely the batsmen are getting better – but the bowlers have all the video replays, slow mo cameras, psychological training, physical training etc. It is impossible for somebody to come anywhere near Don Bradman’s batting average of 99. Leave alone that even Sachin’s record of the total number of international runs seems to be impossible to beat. The bowlers are surely getting better too!!

To quote Michael Mauboussin – the more that the sophisticated players enter the game, the greater is the skill required. As of now in the Indian market the number of active investors (which means the whole pms, active mutual funds, life insurance companies and the small individual investors) are far greater than the index investors. As time goes by the importance of the index investors and their size is likely to increase. As the number of ‘dumb’ people leave the alpha seeking table, they cease to be dumb! So even now if more people index their portfolios AND STOP trying to seek alpha, they will benefit. Assuming that they were buying 3 good scrips, 2 brilliant scrips, and 5 terrible scrips – but they have now gone to an ETF (assumption), it means those 5 terrible scrips will cease to exist over a period of time.. Thus the Long -Short fund which was shorting those 5 scrips which the ‘dumb’ investor was buying has to take more risk while going short. Get the hang?

The jury is still out in India about the whole concept of indexing..hopefully over the next 20 years we will get good data and good journos who know the right way to use the data. I, hopefully, would be pushing up the flowers.