| While all actively managed equity funds aim to | | | | can cause difference in returns for the fund and |
| beat the index, an index fund aims to generate | | | | the benchmark. The index providers during their |
| returns that replicate that of the stock market | | | | review of indices may make a change in their |
| by investing in the stocks that constitute the | | | | composition. In such an event if the re-allocation |
| market index. This sort of equity investing may | | | | process does not take place instantaneously a |
| be suitable for those who are looking to venture | | | | precise mirroring between the index and the |
| into equities, but are afraid to take big bets. Index | | | | benchmark may not happen. By virtue of being an |
| funds, in comparison to actively managed funds, | | | | open-ended scheme, the fund may hold |
| have a lower risk-return profile. Simply put, an | | | | appropriate levels of cash or cash equivalents to |
| index fund will not turn in that high returns as a | | | | fund redemption, which happen on an on-going |
| diversified equity fund would when bulls are on a | | | | basis. Besides the expenses charged by the fund, |
| rampage. At the same time, this category will not | | | | the very process of investing requires payment |
| be as severely hurt as the diversified equity | | | | of brokerage, which will eat into returns. |
| category when stock markets tank. | | | | One thing is clear that index funds aren't designed |
| What are index funds? | | | | to be chartbusters. To this end, an index fund is |
| These funds mirror the performance of a stock | | | | more or less managed by a robot -- the fund |
| market index, by investing in the same stocks as | | | | manager will simply buy shares in a given index. |
| the index, including the number of stocks. | | | | And unlike an active equity fund manager, he will |
| The reason: to ensure that returns from an index | | | | not be tempted to indulge in active trading. |
| fund toe the line of that of the index. In India, | | | | However, in the case of actively managed equity |
| most funds track either the BSE Sensex or the | | | | funds, a fund manager can make costly mistakes, |
| S&P CNX Nifty. However, index funds | | | | such as not being invested when the market |
| currently available don't track other indices such | | | | goes up, being too aggressive when the market |
| as the BSE 100, BSE 200 and S&P CNX 500. | | | | plummets, or just being in the wrong stocks. An |
| An exception here is Benchmark Mutual | | | | actively managed fund can easily underperform |
| Fund’s Nifty Junior BeES, which tracks the | | | | the overall market index that it’s competing |
| Nifty Junior. The Nifty Junior is an index of the | | | | against. An index fund, by definition, can’t. |
| next 50 largest stocks by market capitalisation | | | | Index funds make great sense for investors who |
| after those in the Nifty. | | | | fear that fund managers may make mistakes and |
| Following their stated objective of tracking an | | | | underperform the market. Many investors, |
| index, index funds follow a passive investment | | | | especially the believers of Efficient Market |
| strategy. The portfolio turnover is limited to | | | | Theory, have reason to favour index funds on |
| re-balancing arising out of new subscriptions, | | | | the assumption that trying to beat the market |
| redemption, dividend payout and changes in the | | | | averages over the long run is futile, and their |
| composition of the index. | | | | investments in these funds will atleast keep up |
| Should one expect returns from these schemes | | | | with the market. |
| to exactly match that of the index? | | | | One of the benefits of index funds is that cost to |
| This does not happen in reality and usually there is | | | | investors are kept low. This is because there is no |
| a small difference between the return of the | | | | need to spend on research and other related |
| index and the fund. Such deviations are known as | | | | areas. In view of the passive nature of an index |
| tracking errors and arise out of a number of | | | | fund its expenses should be lower than that of an |
| factors. | | | | actively managed fund. Investors should thus |
| Tracking error is an important variable to judge | | | | examine expense ratios of their index funds, |
| performance of an index fund. Tracking error | | | | which should be lower than that of its actively |
| may arise due to delay in the purchase or sale of | | | | managed counterparts. Within index funds a |
| shares due to illiquidity in the market, delay in | | | | combination of low expenses and low tracking |
| registration of securities. The S&P CNX Nifty | | | | error will help in identifying good index funds. |
| BSE Sensex reflect the price of securities at a | | | | While, index funds are touted as being safer than |
| particular point in time, which is the price at the | | | | actively managed equity funds, it is important to |
| close of a business day. The scheme may, | | | | note that this distinction is on a relative basis. At |
| however, buy or sell these securities at different | | | | the end of the day, these funds invest in equities |
| points during the trading session. Therefore, prices | | | | and so the underlying risks will be those of the |
| at which the scheme trades may not be identical | | | | equity asset class. And among different asset |
| to prices, which are registered for the day. This | | | | classes, equities possess the highest level of risk. |