An Index Fund is a mutual fund which invests in a market index such as the Nifty 50 or the Sensex. The fund invests in index stocks, in the weights in which they are present in the index. It thus seeks to replicate the performance of an index. This does not require a high level of active management of the fund and hence the expense ratio of index funds tends to be low. On the flip side, you also give up the chance of outperforming the index by picking a good fund.
Top Index Funds in India for 2019
|Fund||1 yr return||3 yr returns||5 year returns||AUM (Rs Cr)|
|UTI Nifty Index Fund||17.98%||11.88%||15.76%||936|
|HDFC Index Fund Nifty 50||18.17%||11.85%||15.84%||436|
|ICICI Pru Nifty Index Fund||17.34%||11.48%||15.80%||357|
|SBI Nifty Index Fund||17.87%||11.72%||15.28%||321|
|ICICI Pru Nifty Next 50 Index Fund||10.26%||13.44%||21.87%||265|
*Source: Value Research, Direct Plans Only, Data as on 14th January 2019
Index Fund or ETF?
An ETF or Exchange Traded Fund also tracks an index. However ETF units are listed and traded on the stock market and cannot easily be bought from a fund house (AMC) or sold to a fund house. You effectively need a demat and trading account to buy units of an ETF and you must buy them on the stock exchange.
An Index Fund on the other hand can be bought like any other mutual fund directly from the fund house and redeemed from the fund house. Sometimes, index funds simply hold units of the corresponding ETF of the same AMC and sometimes they directly hold the stocks included in the index. However there are a number of indices which are tracked by ETFs which are not tracked by Index Funds. A few examples include the Nifty Value 20 (NV 20) Index and the Nifty Low Vol 30 (Low Volatility 30).
Low Cost: Index funds are passive trackers in nature and hence have low expense ratio
No fund manager error: Index funds are not vulnerable to poor management because they are not actively managed. They simply track an index. They can have what is called ‘tracking error’ but this is of a much lower magnitude than fund manager error.
Efficient Market Hypothesis: Major economic thinkers have lent their support to the efficient market hypothesis – the theory that no fund manager or investor can outperform the market in the long run. Price anomalies are eventually discovered by competitors and stocks are priced according to their fundamental value. Hence an index fund which represents the market will outperform all active funds in the long run.
No beating the market: An investor buying into this type of fund gives up the chance of beating the market by picking a good actively managed fund.
Mature companies only: Index companies tend to be mature companies who have their best growth years behind them. Investors in such funds do not benefit from the growth potential of small companies.
Expensive Valuations: Companies in the index have been discovered by the market. In other words, investors are buying stocks which are already expensive, after they have become expensive.
Index investing in India
Most index funds in India track the benchmark indices – Nifty and Sensex. The Nifty Next 50 is another popular index. It is an index of the 50 largest stocks that follow the Nifty 50 stocks. The Nifty Value 20 (NV) Index is another popular index for trackers (through ETFs). The Nifty Value 20 tracks relatively undervalued stocks as measured by parameters like PE or Price to Earnings ratio, PB or Price to Book ratio, Dividend Yield and Return on Capital Employed (ROCE). The NV 20 has 5 year returns of 11.97% and 1 year returns of 8.55%. it is tracked by ETFs like ICICI Prudential NV 20 ETF and Kotak NV 20 ETF Other indices like the Nifty Low Vol 30 ETF are also being tracked by ETFs like ICICI Nifty Low Vol 30 ETF. The Nifty Low Vol 30 tracks stocks with relatively low volatility. It has 5 year returns of 15.92% and 1 year returns of -0.52%.