Have you heard about NIFTY 50? BANK NIFTY? NIFTY Next 50? These are the kinds of Index Funds in India, that investors watch out for. As a beginner in stock investing or as a newbie retail investor, you might want to know these terms. For better understanding and better investing opportunities.
NIFTY 50 denotes the index or the weighted average of the top 50 companies in India enlisted in National Stock Exchange (NSE). BANK NIFTY denotes the indices that capture the market performance of Indian bank stocks. In the same way, NIFTY Next 50 shows the performance of the next 50 companies after the top 50. S&P 100 is a stock market index that globally shows the performance of the top 100 multinational companies.
So, as a newbie are you wondering whether to invest in Index Funds or will investing in Index Funds is a smart option? Is it a smart retail investor’s secret weapon?
“Index Funds are a safe way to save for retirement”, and “ A low-cost index fund is the most sensible equity investment” are the words of the renowned fundamental investor Warren Buffet. So, why does a smart cookie like Warren Buffet recommend investing in Index Funds? Let’s speculate!
What is an Index Fund?
Let us first look at what the index means. In simple terms, an index is a bunch of securities, derivatives or other such financial instruments. It is a performance indicator of market class, market sector, asset or investment strategy.
An index fund is a kind of mutual fund, where the investment is passively managed. The intention is to seek average returns by following the market index. The funds are invested in specific stock indexes like NIFTY 50, NIFTY Next 50, SENSEX, NIFTY MIDCAP100, etc.
In Mutual Funds, the fund manager selects the industries, buys different stocks and actively builds the portfolio. But in Index Funds, a fund manager has to invest in a particular index only. For example: If an Index Fund is invested in NIFTY MIDCAP 100, then the fund manager tracks and invests only in it.
In Index Fund, the fund manager replicates the specific stock market index to build a portfolio. That is why, it is a passive investment strategy. The holdings should match the specific stock market index. The performance of both the holdings and the weightage of each stock are replicated.
A specific index fund like NIFTY50 or SENSEX will invest x% of its fund in a particular company if the index has given the company x% of its weightage. The performance will be the same as that of the index when the fund replicates the profile of the index (either entirely or a large chunk of the stock market).
If you observe, and when you start investing in stocks, you will get to know that on regular intervals, the stock market indices rebalance their portfolios throughout the year. In the same way, index funds also adhere to such changes.
One of the primary roles of an Index Fund manager is to keep track of such stock list changes or weightages. The Fund Manager has to buy or sell the units of the stock, to align the weightages to the index in the portfolio.
Now that you know how Index Funds mimic a benchmark index and provide you with an option to passively invest, let us look at why should you invest in Index Funds.
WHY SHOULD YOU CONSIDER INVESTING IN INDEX FUNDS?
Index funds are a good long-term investment option. Investors invest in index funds as a part of their retirement planning. Even though it does not outperform the market actively, it can have its own perks. Let’s know what they are:
Low Management Expense
Index funds are better than actively managed portfolios in terms of their ‘low management expense ratio. So, even as a passive investment strategy it is affordable as the fund’s operating cost is low. Such funds help you spread out, and gain good returns in a long time period.
The safety in investing depends on the index they invest in and follow. Market volatility is a factor, but the strategy here is to mimic the overall risk and return. So, that way Index Funds perform well in the long term.
For example Motilal Oswal’s Nifty 50, with an expense ratio of 0.01%. It gave returns of 50.50% within the end 2 years. The average (AUM) Assets Under Management at the end of June 2021 was ₹76.28 Crore.
The expected return of the portfolio is greater in the long term. Hence, you can think of it as a secure and good investment option. You can use it for a broad exposure of your portfolio. The tracking although passive, tracks portfolios of multiple stocks. Hence, the investors enjoy the benefits of diversification. For example: If you invest in S&P 100, you enjoy the benefits of 100 stocks globally across various sectors. The same goes for NIFTY 50 or SENSEX. You get varied exposure through this passive investment strategy.
Suppose a single stock is underperforming, and it is a smaller component of a larger index fund, then in the long run, the effect of it will not be that damaging.
The Fund Managers follow a defined mandate for the funds to be invested in different kinds of securities. The funds are regulated and automated. Hence, there is no manipulation or human discretion in the investment decisions made.
The buying and selling of stocks is less. It exempts the investors from the tax resulting from expensive short-term capital gain. Hence, investors enjoy tax benefits because of the low turnover. The capital gains are fewer and hence there’s wealth creation over a longer period.
As mentioned earlier, Index Fund is a passive investment strategy. Hence, the Fund Manager has to track specific stock market indexes and has to rebalance the portfolio. This is easier than managing Mutual Funds.
WHAT ARE THE COSTS ASSOCIATED WITH INDEX FUNDS?
Low-cost index funds cost between 0.2% or 0.5% to less than 1%. Some companies also offer an expense ratio of 0.05% or less also. Whereas, actively managed mutual funds are comparatively expensive. They charge a high fee of more than 1% to 2.5%
WHAT ARE SOME RISKS OF INDEX FUNDS?
Index Funds replicate market indices. So, it is subjected to the same risks as various securities in the specific index it follows.
In active mutual funds, the fund managers have the flexibility to increase the cash allocation, during volatile market movements. But, in Index Funds it is not the same. The discretion limits this flexibility in Index Funds. The Fund Manager has to fully allocate the assets at all times in the specific index. To buy or sell undervalued or overvalued securities is not an option in index funds.
There are instances where a fund’s performance does not match the index. It results in a tracking error. Even though it does not involve human bias, it is subjected to tracking errors. It can happen when the fund is allocated in the sampling of securities in the market index.
Tracking errors can also occur due to fluctuations in index components, liquidity provisions, or any corporate actions.
Chances To Underperform
Index Funds do not involve the Fund Managers actively. Unlike active mutual funds, they do not have a structured framework to approach investment. It is likely to underperform due to the tracking errors, the fee, the expenses, etc.
TOP INDEX FUNDS IN INDIA
Here’s the list of Top Index Funds in India that have a good return on this passive investment strategy:
1. UTI Nifty Next 50 Index Fund
It is one of the best Index Funds in India to invest in. It aims to give returns that closely correspond to net returns of securities, before expense. Like any other Index Fund, this is also subject to tracking errors.
2. Motilal Oswal S&P BSE Low Volatility Index Fund
It is launched by Motilal Oswal Mutual Fund, which ranks among the top Index Funds in India. Its primary objective is to give returns prior to expense.
It corresponds to net returns that represent S&P BSE Low Volatility Total Return Index. It is subject to tracking errors like any other Index Fund, even the top Index funds in India.
3. Axis Nifty Next 50 Index Fund
This index fund also is one of the best index funds in India, that one can invest in. The objective of this fund is to give returns before expense, that nearly correspond to net returns of Nifty 50 Index Fund. This index fund, like others, is subject to errors in tracking.
4. Nippon India Nifty SmallCap 250 Index Fund
It is one of the best Index Funds in India and is represented by Nippon India Mutual Fund. The aim is to provide investment returns that nearly match the securities represented by Nifty SmallCap 250 Index.
5. IDFC Gilt 2028 Index Fund
The aim of the IDFC Gilt 2028 Index Fund is to give the best investment returns that nearly match the total returns of CRISIL Gilt 2028 prior to expenses. This index fund is launched by IDFC Mutual Fund.
FAQ about Index Funds
How to invest in index funds in India?
In the online process, you can invest by opening a mutual fund account through a secured and authentic website. You need to complete KYC procedures. Finally, depending on the financial objectives, you can select the funds you want to invest in. You can select the appropriate fund and transfer the desirable amount.
In the offline process, you need to fill out the KYC, submit the required information and based on how much you can invest, choose the index fund you want.
What is a Nifty 50 Index Fund?
How to buy a Nifty 50 Index Fund?
Is index fund safe?
How to invest in US index funds from India?
What is indexation in mutual funds?
What are indexes and ETFs?
ETFs, (Exchange Traded Funds) are funds that are traded the same way as securities. One can buy and sell them in open stock markets unlike mutual funds, but just the same way as regular securities or stocks.