Index Funds

There are several types of Mutual Funds available for all types of investors. Each fund type is classified based on characteristics like,

• Asset class (Debt, Equity, etc.)

• Structure (Open-Ended, Close-Ended, etc.)

• Investment goals (Growth, Income, Tax-Saving, etc.)

• Associated risk (Low, Medium, High)

• Specialised funds (Sector, Index, Funds of Funds, ETFs, etc.)

Each of these broad characteristics can be combined to curate fund portfolios suitable for any investing style. Index Funds are specialised mutual funds tied to the portfolio of a securities exchange index. An exchange index is a group of securities selected on varied criteria (market-capitalisation, industry, size etc.). In India the benchmark indices are: BSE Sensex and NSE Nifty. Some global indices that we know are: Dow Jones, NASDAQ, Nikkei, FTSE 100 etc.

Since these funds are tied to the portfolio of an index, the funds comprise the same proportion of securities found in the index. Therefore, for example a fund tied to the NSE Nifty 50 index will have the same 50 securities. This also means, the performance of an index fund depends on the index’s performance.

The securities in these funds are not all equity-oriented; some are bond-market instruments as well. These funds are also called index-tied or index-tracked funds. These fund types are not active but passive because they are curated not to out-perform, but rather to emulate. Investing in these funds is relatively safer and they don’t need to be watched continuously.

What Is An Index Fund

Index Fund Investment Plans Recommended by Angel BEE

Index funds passively track performance of the index they’re tied to, so they can typically deliver returns like the benchmark. When there’s a difference between the index’s and fund’s performance, it is called a tracking error. A tracking error, therefore, is a measure of the deviation of the fund’s returns from the benchmark of the index it follows. Simply put, it is the difference between the index fund’s return and its benchmark return. The lower the tracking error, the better the fund’s performance.

Since these funds are simply expected to follow an index, the returns are predictable. Investors who are conservative or risk-averse usually invest in these funds when they don’t want to actively manage their fund’s performance. The most recommended funds are the ones which are less prone to equity-related volatility and earn great returns when markets are on an overall upward trend.

Top Index Funds in India

Unlike funds which need active participation to buy and sell stocks within a portfolio, index funds are passive. The follow benchmarks of indices and give returns which are the same or like these benchmarks. The top funds will have the least tracking error or deviation from the benchmarks they follow and will give the best returns when markets are doing well. These funds are also the least expensive in their class, making them more cost-effective. The three crucial things to look for in top funds are, expense ratio (or cost effectiveness), the tracking error (deviation from index benchmark) and returns on investment.

Everything You Need to Know About Index Funds

• Tied to an Index: Index funds invest in a securities exchange, in India the main ones are BSE Sensex and NSE Nifty. The portfolio of these funds has the exact allocation as the indices they follow, for example a fund invested in the NIFTY 50 index will have the same 50 securities.

• Tracking Error: This type of fund’s performance is linked to the index it follows. The fund’s aim is not to out-perform the index’s benchmark, but to emulate or mimic it. Any deviation or difference between the index’s benchmark and the fund’s performance is called a tracking error. This is also an indication of the fund’s performance. The lesser the deviation, the better is the fund rated.

• Passively Managed: These funds do not need active participation from you, all you need to do is track the index (the fund is tied to) and you’ll get an idea of your portfolio’s performance.

• Less Risky: These funds are considered less risky even though they’re equity-oriented. The reason is, they aren’t expected to out-perform during market highs.

• Good Returns: During positive market cycles these funds give good returns for conservative investors.

Why Index Funds?

Index funds are recommended as the safest investment option for any kind of investor. If you are new to the world of equity-oriented investments, you might consider investing in these funds. There are many reasons why even moderate investors have at least one of these in their portfolio as well. Here they are:

• Less Risk and Good Returns: These funds are ideal if you’re a conservative investor, or, have a low appetite for risk. Since each of these fund portfolios is tied to an index, they are not expected to cross the index’s (they follow) benchmark. When the index is doing well, your fund will automatically give you great returns.

• Less Expensive: The expense ratio of these funds is comparatively less than others (in their class). This makes these funds cost effective and a great option for new investors or those on a fixed-income.

• Passively Managed: Unlike most equity-oriented funds where you must constantly track the portfolio for stock performance, these funds are passive. Which means, even if you’re not a market expert or an aggressive investor, you can simply follow the index your fund is tied to. This will give you an idea of how much returns to expect on your investment.

Get Better Returns with Index Funds

An ability of an index fund to get better returns, depends entirely on the index it is tied to or follows. If your fund is invested in a relatively good index, there is a high probability of consistently high returns. In positive market cycles the best indices out-perform the benchmark, which means, if your fund is tied to any of them, you can expect great returns from your investment. Moreover, since the expense ratio is less compared to other equity-oriented funds, these make for a great investment option for professionals who are starting their career or who individuals who are retired.