Passive fund management has earned great name for itself in 2016 in developed markets. Actively-managed mutual funds have struggled to beat passively-managed funds during the year. Is it time for Indian mutual fund investors to take a close look at passively-managed index funds available in the market?
Index funds, as the name suggests, invest in an index. These funds purchase all the stocks in the same proportion as in a particular index. This means the scheme will perform in tandem with the index it is tracking, save for a small difference known as tracking error.
What about extra returns?
Well, it is true that the fund manager in an active fund tries to earn extra returns over the benchmark index through active stock picking. However, many studies abroad have successfully proven that it is almost impossible to beat the benchmark index year after year.
Unlike actively-managed funds, index funds passively track the performance of a particular index. These funds are not meant to outperform the market, but mimic the performance of the index.
Since the portfolios of these schemes are not actively managed – that is, they are not buying and selling stocks to generate extra returns – they incur lower expenses than actively-managed funds. For example, UTI Nifty Index Fund has an expense ratio of 0.20 per cent, whereas an actively-managed funds my charge around 1 per cent on direct plans and around 2 per cent in regular plans.
But do index funds always match the returns provided by the index they track? Some schemes fail to match the performance of the index. This is called tracking error, and investors should pay attention to this figure while investing in an index fund. The tracking error measures how much an index fund's returns deviated from the benchmark it is tracking. The lower the tracking error, the better the fund’s performance.
Should you opt for them?
Investing in index funds, you have three options. One, you can invest in a fund which tracks the Sensex and secondly, a fund that tracks the Nifty. The Nifty has 50 companies in its index compared to Sensex which has 30 companies. Thirdly, you can invest in an index plus fund. These funds invest majority of their assets into a particular index and the rest of the assets are managed actively.
Index funds may be making waves in the US and other developed markets. However, in emerging markets like India, index funds are yet to make a splash. This is because in a growing market like India there are many companies that would grow at a faster pace and offer index-bearing returns. Many mutual fund managers believe that the trend may continue for at least the next five years. That means you can continue to bet on actively-managed schemes.
Index funds, as the name suggests, invest in an index. These funds purchase all the stocks in the same proportion as in a particular index. This means the scheme will perform in tandem with the index it is tracking, save for a small difference known as tracking error.
What about extra returns?
Well, it is true that the fund manager in an active fund tries to earn extra returns over the benchmark index through active stock picking. However, many studies abroad have successfully proven that it is almost impossible to beat the benchmark index year after year.
Unlike actively-managed funds, index funds passively track the performance of a particular index. These funds are not meant to outperform the market, but mimic the performance of the index.
Since the portfolios of these schemes are not actively managed – that is, they are not buying and selling stocks to generate extra returns – they incur lower expenses than actively-managed funds. For example, UTI Nifty Index Fund has an expense ratio of 0.20 per cent, whereas an actively-managed funds my charge around 1 per cent on direct plans and around 2 per cent in regular plans.
But do index funds always match the returns provided by the index they track? Some schemes fail to match the performance of the index. This is called tracking error, and investors should pay attention to this figure while investing in an index fund. The tracking error measures how much an index fund's returns deviated from the benchmark it is tracking. The lower the tracking error, the better the fund’s performance.
Should you opt for them?
Investing in index funds, you have three options. One, you can invest in a fund which tracks the Sensex and secondly, a fund that tracks the Nifty. The Nifty has 50 companies in its index compared to Sensex which has 30 companies. Thirdly, you can invest in an index plus fund. These funds invest majority of their assets into a particular index and the rest of the assets are managed actively.
Index funds may be making waves in the US and other developed markets. However, in emerging markets like India, index funds are yet to make a splash. This is because in a growing market like India there are many companies that would grow at a faster pace and offer index-bearing returns. Many mutual fund managers believe that the trend may continue for at least the next five years. That means you can continue to bet on actively-managed schemes.
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