One of the major limitations of an index fund is that it will not outperform the market as it invests only in the index
Individual investors are increasingly investing in index funds because of the low cost structure and higher returns than fixed income instruments. They are investing in new fund offers (NFOs) of index funds—fund houses have launched over 30 schemes in the last one year and many more are in the pipeline.
In January this year, index funds reported net inflows of Rs 4,914 crore, the highest ever, according to data from the Association of Mutual Funds in India. The total assets under management was Rs 49,905 crore, a three-fold increase over the same period last year. In January, the share of index fund folio rose to 18% vis-a-vis 8% during the same month last year.
Last week, Motilal Oswal Asset Management Company launched Low Volatility factor-based ETF and Index Fund—Motilal Oswal S&P BSE Low Volatility ETF and Motilal Oswal S&P BSE Low Volatility Index Fund. These are open ended schemes replicating the S&P BSE Low Volatility Total Return Index. The low volatility strategy involves buying stocks which have higher stability in price movements based on past returns. Subscription to the NFOs will close on March 16.
Betting on index funds
So, why are individuals flocking to index funds now? Experts say the volatile equity markets and low interest rates have propelled many investors to look for index funds. Sushil Jain, CEO, PersonalCFO.in, says due to the India growth story a lot of new investors want to participate in the equity market and in a comparatively safer way with limited knowledge. “Due to falling interest rates investors have to find other ways of investment where they can get long-term appreciation. We recommend that investors consider index funds for their core portfolio as for long-term investments they do not require much actively managed funds. One should be fairly balanced between active funds and passive funds to get stable returns,” he says.
Investors find index funds well-diversified, simple and transparent. As these funds are low in costs, they are suitable for the core portfolio and are helpful in asset allocation. However, one of the major limitations of an index fund is that it will not outperform the market as it invests only in the index and is not actively managed and has limited exposure to the selected index.
What to consider before investing
Those who do not want to take any risk on their near-term investments due to the volatility in the markets should ideally go for index funds. Also, if you are unable to select quality equity mutual funds schemes, then index funds are a better option. However, if willing to take some risks, go for large-cap equity funds.
The returns from index funds will be in sync with the indices and the difference in returns will be tracking error. For instance, a Nifty 50 index fund will generate similar returns to the Nifty 50 index, which is the benchmark. Lower the tracking error, the closer will be the returns to the benchmark. Experts say investors should select index funds that track a broad market index rather than funds that track a sector, a theme or a narrow market cap.