The concept of Index Funds became popular with renowned investor ? Warren Buffet who claims that investors can generate good returns with passive funds such as Index Funds. These funds are not actively managed hence, do not attract high fees chargeable to brokers or fund managers. Index funds are mainly funds that replicate the stock indices such as tracking the 30 stocks forming part of the Sensex in India or the 50 stocks of Nifty. These Indian index funds include investments in each of the respective stocks as per their weight proportion in the respective stock index.
Advantages and Challenges faced by Index Funds in India
Though the management of these funds are easier in nature since no decision is required to be made with regards to the stocks to be held, their quantity or their holding time duration; it is imperative to understand that these funds can never do better than the stock index nor worse. These funds are also cheaper in nature due to the low management and transaction costs. These costs are further reduced due to lack of portfolio churning which results in cost saving.
Despite the fund being an exact replica of the stock index; in India certain cases of tracking errors have occurred where the fund has either out performed or under performed in comparison. Tracking errors are measured by how closely the fund?s stocks are benchmarked to the index.
In addition to the above, lack of volatility is another advantage in these passive index funds. Hence, these stocks are ideal for investors who are risk averse but wanting to invest in equities. Though, actively managed funds generate higher returns, they carry high risk. These funds are highly volatile and may fall by high margins too.
A major advantage of index funds is the fact that these funds can be traded on the exchange at any point of time during the day at the prevailing price at that specific time, thereby; allowing investors to take advantage of the price. However, active or normal funds can be sold only at the end of the day on the price equivalent to the Net Asset Value (NAV).
Past records of India have also shown that though index funds have shown relatively lesser returns or upsides as compared to normal funds; there has been no resultant negative return which has been visible in actively, diversified funds. This shows that though the upside in index funds in India was lower, the losses caused by poor calls taken by fund managers were limited.
Index funds are yet to be popularized in India where few middle cap stocks can actively beat the stock indices. However, these are ideal for those wanting to minimize their risks, costs and losses but still invest in equities. The perfect solution to maximize returns is to invest in both active as well as passive stocks so that one cannot only enhance their returns but also limit their costs and risks.