Which index fund should investors pick: Nirmal Bang

Global investment legends like Warren Buffet and Benjamin Graham have always maintained that index funds are one of the best investment vehicles for small investors.

However in India, index funds have not picked up as they have in the global markets. But with many equity funds languishing in the last one year, investors can certainly look at investing in index funds with a long-term perspective. In India it is always believed that 'active' funds are better than 'passive' funds, which are also known as index funds. Unlike 'active' funds where fund managers actively buy and sell securities, in index funds the managers merely try to replicate the overall market's performance. But many investors are still unaware of the concept of index funds. First we will try and understand what index funds are and then we will know how they function. Index funds invest in a basket of stocks of an index (like Sensex, Nifty, Junior Nifty or even sectoral index such as Bankex and Infrastructure) in a similar manner that reflects the allocation of a benchmark index. Index funds invest in stocks that form an index and are in the same proportion as that of the stocks within the index. For example, a Nifty Index fund will only invest in the 50 companies that constitute the index and the weightage of a company in the fund portfolio is same as that of the weight of the company in the index. Why Pick Index Schemes? We must have read hundreds of times of how to pick up a mutual fund. Passive investing is a gift for those who want a fair slice of their wealth in the stock market and are willing to settle for index returns over time - for very low fees. Selecting a mutual fund scheme to invest from a universe of hundreds of open-ended equity schemes can be quite confusing. Since the equity markets can be a puzzling place for a new investor, the best way to start investing is through an index mutual fund. The best thing about an index fund is that since it invests in companies that make up the index and often in the same proportion, the returns tend to be similar to that of the index. Which index fund should investors pick? This concept has still not picked up in India and we have hardly over a dozen index schemes present in the market. Before investing, investors should look at the cost and the tracking error, which can have an overall impact on returns. So, investors can look at investing in say schemes such as HDFC Index Sensex Plus, which aims to invest 80% to 90% of its assets in companies that form the Sensex and between 10% and 20% of the assets in companies, which are not included in the Sensex. This is not a 100% index scheme but manages a minimal part of the corpus to boost the overall returns, which also shows in its performance. So, say in the last one year the Sensex has given return of 22.34%, while this fund has managed to give returns of around 25.22%. In a Nutshell Globally, most fresh inflows come usually into index schemes as they are cost effective. However in India, investors still go to active fund management with higher cost. But long-term investors can look at investing in index funds which can replicate the benchmark returns with lower costs. Source: Nirmal Bang's Beyond Market Click here to read the full magazine Disclaimer: The views and investment tips expressed by investment experts/broking houses/rating agencies on moneycontrol.com are their own, and not that of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.