What Are Index Mutual Funds?
Investing in index funds can be fulfilling for investors with low-risk appetite and long-term investment horizon. Types of mutual funds cover several categories and index funds are one such specific category which has made latest entry among mutual funds. Index funds were introduced in 1976 by the vanguard group founded by Bogle. Bogle wanted to offer a mutual fund that needed passive management instead of active portfolio management. Active mutual funds were popular investment products in the US market since decades before and during the time index funds were launched in the U.S. Soon enough index funds started gaining popularity among US investors who preferred low-risk stable returns over long tenure horizon.
People started investing in index funds in more numbers and in present times index funds comprise around 22 % of the equity mutual funds assets. Just in the US, the share of index funds has doubled within the past ten years. Index funds did not remain contained in America, this specific type of mutual fund which was low key up till a few years back started finding acceptance world over. In India, several index fund products have been introduced by the top asset management companies.
Types of Index Mutual Funds
There are several types of mutual funds, and an index fund is one of those. An index fund is a mutual fund the portfolio of which mimics portfolios of the popular indexes of the country. Indexes of the country are a portfolio of diversified equity stocks. Fund rating agencies, while ranking mutual funds, first contrast their performance against the standard benchmark category index. Investing in index funds is almost like investing in benchmark index funds except that benchmark indexes are for base comparison and not for investment. Most investors must be aware of the popular indexes of India, included among these are BSE Sensex and NSE Nifty.
An index fund is considered a mutual fund as the fund also comprises of a well-diversified portfolio, yet the underlying difference is clear. Other types of mutual funds require active fund pick and portfolio management, and they do not mimic the benchmark index fund. Investing in an index fund, which is a replica of a benchmark index fund, is investing in equity portfolio having a base risk and return profile. There are two types of index funds in India. Index exchange-traded funds or Index ETFs and open-ended Index mutual funds. Index funds can be equal weight index funds which comprise an equal proportion of all portfolio constituents. A benchmark index portfolio return will never be out of tune with market trends. A benchmark index portfolio is actually a scientifically chosen sample of the stock market, a sample which shows exact behavior as the population from which it is derived.
Features of Index Mutual Funds
Types of mutual funds can be several. There are mutual fund subcategories within a particular category. Thus there is the debt based, equity-based and hybrid mutual funds. Within equity-based mutual fund, there are the small cap, medium cap, and large-cap mutual funds and mixed cap mutual funds. Index funds are equity mutual funds comprising of exactly same stocks in the same proportion as the portfolio of a benchmark index which the fund is tracking. Investing in index funds is a passive investment into an already constructed portfolio, unlike active investment of other equity-based mutual funds.
Index Mutual Fund Portfolio
A portfolio of mutual funds consists of stocks and stock proportion as decided by the fund manager, who employs a whole team of analysts to manage the portfolio actively. All types of mutual funds apart from index funds have portfolio different from any index. The category of mutual fund determines the type of investment instruments in the fund portfolio. For example, an equity-based mutual fund mostly comprises equity and equity-related market instruments. The portfolio of the mutual fund is vastly determined by the objective of the fund, whether short term or long term, liquidity or wealth accrual and several other objectives. Investing in index funds is a more simple decision.
All types of mutual funds excluding index funds require active portfolio management. The mutual fund’s portfolio needs to be continuously managed for risk, return and volatility parameters. Fund managers actively manage mutual fund portfolio with the help of team members. Active fund management has gained the proportions of complex modern science; fund managers employ basic and complex tools and models to carry out fund analysis and management. In contrast, investing in index funds portfolio components does not require active management on the part of the index fund manager. Index fund manager does not try to outperform the index portfolio, but only to match it.
Index Mutual Funds Expense Ratio
Expense ratio is the fee charged by the fund manager to manage the fund portfolio. It is usually a small percentage of the returns earned from a mutual fund scheme. In comparison to all other types of mutual funds index funds have a low expense ratio. Investing in index funds is considered low cost as expense ratio is significantly low of around 0.2 %. Actively managed mutual funds have an expense ratio of 1 % or more for the direct plans and 2 % or more for the regular mutual fund schemes.
Index Mutual Fund Lock-in Period
lock-in period for most types of mutual funds is three years. However, that would depend on the fund objective. Funds with short-term liquidity objective may have a lock-in period of one year. Investing in index funds has an advantage considering the lock-in period requirement. The lock-in period of index funds can be very less. For example, Franklin India index funds have a lock-in period of just 20 days, although exit load of 1 % is levied for redemptions up to Rs 10 lakhs within one year period.
SIP Index Mutual Funds
These days almost all types of mutual funds are offering investment through the systematic investment planning mode besides the lump sum investment option. Investing in index funds through SIP mode is also possible as most index funds offer SIP mode of investment. SIP can be as nominal as Rs 500 a month for the index funds as well as other mutual fund plans. In fact, most financial experts would advise the SIP mode of investment in index funds over the lump sum mode as index fund portfolios essentially hold equity stocks which are not shielded from market volatility.
Risk involved in Index Mutual Fund
The risk associated with investing in index funds is actually the benchmark risk. Benchmark index is not free from volatility as they are essentially a portfolio of equity stocks. The risk associated with a benchmark index can also be thought of as risk due to natural stock market volatility. All types of mutual funds in the equity funds category try to outperform the benchmark index on the risk and return parameters. Mutual funds portfolios which show risk above the benchmark index risk are actually showing abnormal risk or risk that is higher than the risk associated with natural stock market volatility.
Top ranking mutual funds that score high on the risk parameter can screen out volatility and lower risk below the benchmark index risk. If you are an investor with appetite for equity funds investment then investing in index funds is a base risk option when compared to investing in other types of mutual funds in the equity fund categories. However, when compared to all investment products including debt based and savings products, an index fund can be said to have a moderate risk as all other equity mutual funds due to being equity portfolio.
Index Mutual Fund Returns
Investing in index funds can be highly rewarding. As compared to investing in other types of mutual funds in the equity and nonequity category, investing in index funds is yielding high returns. On comparison of the one-year returns, we find that returns of the popular index funds are high in comparison to other equity-based types of mutual funds. The one-year returns of top index funds have been 19 to 20 %. Most ELSS have shown negative returns and high volatility below one year returns recently, and the returns only started showing positive trends from one-year returns. Index fund returns are almost equal to the returns of benchmark index which they track; any difference is due to tracking error. The lesser the difference, the better the tracking considering this situation the one-year returns of the index funds appear winsome.
Index Mutual Fund Redemption
Another reason why investing in index funds seems an attractive option is its open-ended feature. Like other types of mutual funds in the equity funds categories, index fund comprises of composite index fund units. Units of index fund units can be redeemed or purchased based on the present day NAV of the index fund unit. Asset management companies daily compute the NAV of the equity-based mutual funds including index funds and publish it on the online portal. So index funds can be bought and sold in units much like the equity shares (subject to prevailing stock market conditions).
Index Mutual Fund Taxation
Index fund returns are not tax exempt in India. Investing in index funds as well as other types of mutual funds does not derive tax benefits unless investors opt for investing in the tax saving mutual fund plan. Index fund returns are considered as income and add to the taxable income base. Contributions made into index fund scheme as yearly lump sum amount or SIP mode does not qualify for a deduction on the taxable income base. If index fund units are redeemed then short term or long term capital gains taxes of 15 % and 10 % (without indexation) is applicable depending upon the holding period.
Best Index Mutual Funds in India
|Index Fund||Returns (one year) (%)||Expense ratio (%)||Tracking error (%)|
|Open-ended nifty funds|
|Benchmark index Nifty 50 TRI||19.21||NA||NA|
|UTI Nifty Index Fund||18.75||.2||.1|
|HDFC Index Fund Nifty||18.84||.3||.1|
|ICICI Pru Nifty Index Fund||17.69||1||.12|
Open-ended Sensex funds
|Benchmark index: Sensex TRI||22.63||NA||NA|
|HDFC index fund||22.06||0.3||0.02|
|LIC MF index fund||20.07||1.68||0.06|
|Reliance index fund||21.57||0.87||0.06|
Nifty 50 ETFs
|Benchmark index: Nifty 50 TRI||19.21||NA||NA|
|SBI ETF Nifty 50||19.15||0.07||0.1|
|UTI Nifty ETF||19.13||0.07||0.1|
|ICICI Pru Nifty ETF||19.01||0.05||0.12|
|Benchmark index: Sensex TRI||22.63||NA||NA|
|SBI ETF Sensex||22.52||.07||.02|
|UTI Sensex ETF||22.55||.07||.02|
|LIC MF ETF Sensex||22.59||.01||.06|
Sectoral Index ETFs
|Benchmark Index: Nifty Bank||15.93||NA||NA|
|Kotak Banking ETF||16.42||.2||.42|
|SBI ETF Nifty Bank||16.43||.2||.42|
|Benchmark index: Nifty PSU Bank||.06||NA||NA|
|Reliance EFF PSU Bank BEES||.61||.54||2.30|
Nifty 100 ETFs
|Benchmark: Nifty 100 TRI||18.14||NA||NA|
|LIC MF ETF Nifty 100||17.79||.26||.16|
|ICICI PRU Nifty 100 ETF||17.22||.49||.16|
|Reliance ETF Nifty 100||16.82||1.15||.16|
Other Index ETFs (specific market segments)
|Benchmark index: Nifty Next 50||11.14||NA||NA|
|UTI Nifty Next 50 ETF||12.38||0.22||0.58|
|SBI ETF Nifty Next 50||11.92||0.20||0.59|
|Benchmark : Nifty midcap 100||10.23||NA||NA|
|Motilal Oswal Midcap 100 ETF||9.58||0.20||0.64|
Equal Weight Index Funds
|Benchmark: Nifty 100 equal weight index||10.77||NA||NA|
|Sundaram smart Nifty eq. wt. fund||9.46||1.5||1|
|Principal Nifty 100 eq.wt.fund||12.21||0.4||0.27|
Index funds in India are gaining popularity. Investing in index funds is now more fulsome as compared to investing in other types of mutual funds due to low costs (expense ratio) and returns which compete with top mutual fund scheme returns in the country in the category of equity-based scheme returns. Following are the recent returns reported by the top performing index funds of India.
How to start investing in index fund schemes?
As compared to other types of mutual funds which offer an indirect way of investing, the mode of investing in index funds can be through index ETF funds and index mutual fund scheme subscriptions. Investors can deal in index ETFs through stock exchange brokers and open a demat account to transact online in Index ETFs. However, SIP mode is not available for index ETF investments. Investing in index funds is also possible through the indirect mode of purchasing mutual fund index scheme. You can start an index fund SIP now. Visit the secure policy bazaar portal to compare top index fund schemes and other types of mutual funds for investing in index funds or other types of mutual funds.