SHOULD RETAIL INVESTORS INVEST IN INDEX TRACKER FUNDS RATHER THAN ACTIVELY MANAGED FUNDS?
This essay sets out to know which type of investment fund is better for a retail investor. By this, we will consider the meaning and operations of an index tracker fund, as well as that of the actively managed funds. Furthermore, identify the advantages of index tracker funds over actively managed funds and draw conclusions in relation to the topic above.
What is an index? An index is a group of securities which gives reports of variations in the activities of a stock market. For instance, these reports could be changes in monthly or annual returns or prices, usually recorded in percentage. Index tracker fund managers track indices which measures the performance of large amounts of securities with the aim of being able to follow up easily with the overall achievements of the market at a minimal expense. [ISAs and investments fund (2010)]. Such indices are refered to as the broad market index. Types of index approaches include; Index mutual funds and index-based exchange-trade fund (ETF), which are designed to follow-up the performance of an index. Generally, these funds operate by integrating different “collections of investments” within the same securities which make up the index. [David Stevenson (2011)].
On the other hand, there are managers who are believe that the market is inefficient. Such managers claim to be skilled enough to beat the market complications. They are called active managers, but actively managed funds have high management fees and are more expensive to maintain, as a result, it becomes almost impossible for them to outperform the market. Hence, we can confidently suggest that investors should invest in index tracker funds rather than actively managed funds because of the high cost disadvantages and non-persistence to beating the market value. [Agarwal, V.; N. D. Daniel; and N. Y. Naik (2009)].
Operations of Index tracker and Actively managed funds.
Index tracker (operations, advantages/disadvantages):
Indexes give appropriate records of the various performances of the market, they show profits and losses. With an index it is easy to observe how a market operates and one can even attempt to predict future outcomes. It is important to note that a higher return does not necessarily signify a better index. When rating the performance of an index, the overall growth of the company as well as the certainty of the investment style should be considered. A company’s value is measured by the current market price per share of its stock and the number of shares outstanding, it is called the market capitalization. A constantly updated market index, points out how well or poorly a market is performing, also, whenever a new development is made in a market or organisation, such as price change, government policies or change in management, the records are influenced and reflected immediately in the index, thus, the behavior of the market system and risks, are known at any point in time. [Market indices, moneyterms.co.uk].
Index managers assume the market is very reliable at all times and they believe the market prices depict the correct values of the stocks / bonds. As far as index managers are concerned, the market cannot be out-performed. The index managers operate in a very simple way. They are guided by the market index instead of making futile efforts to outplay the market. Index managers track the indexes that depict the market which they are interested in. For instance, FTSE100 index represents the U.K stocks and would be a good investment for an investor who is interested in the U.K stock market. Likewise, an investor who wants to own bonds in the chinese market could chose a fund that tracks the ishares FTSE China Index. [Monevator “the investor” (2008)].
An index manager is also called a passive manager because he/she does no active participation and for that reason, expenses...
References: 1. Agarwal V, N.D Daniel, and N.Y Naik. “Role of Managerial Incentives and Discretion in Hedge Fund Performance.” Journal of Finance (2009).
3. Lionel Martellini, Philippe Priaulet, Stéphane Priaulet (2003) “Fixed-income securities: valuation, risk management and portfolio strategies”, Pages 214 – 216.
7. Davis Stevenson. “Adventrous investor, index tracker puts consistent dividends first.” Financial times, November 18th, 2011.
11. Alan Gregory and Ian Tonks “Performance of pension schemes in the UK” March, 2006.
12. Elton, Edwin, Martin Gruber, Sanjiv Das and Matthew Hlavka, “Efficiency with costlt information: A reinterpretation of evidence from managed portfolios,” Review of financial studies, (1993), pages 1 – 22.
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