The Hindu Business Line : A good case for investing in index funds

Fund scenario
Index products are small in size vis-à-vis diversified funds
Actively-managed scheme will face great risks when the market is declining

Indian investors seem to detest index funds. If you think that was a very sweeping statement, consider what has been accomplished by these funds in the backdrop of the scorching pace in which the indices have moved up, a feat that has been eclipsed entirely by the market's overwhelming interest in diversified equity funds.

That index products are small in size when compared to their diversified counterparts is nothing new. Their asset bases have remained limited throughout history, while the broad-based schemes have become bigger and bigger in proportions. And they have also captured all the glory.

Where does this leave investors in index funds? Check out a few statistics to arrive at your own conclusion. The last one year has seen the highest performing Nifty tracker (managed by Tata MF) deliver as much as 97 per cent. The best Sensex chaser (in the Reliance MF stable) has given 92 per cent. And the one-year average (as on April 21) is about 80 per cent - a fairly decent show if you view this against the 85 per cent turned in by the diversified funds category.

The statistics, dry as they are, tell a story of their own: Index funds have been no babes in the woods. There is clearly merit in investing in these products if one wants to go in for passively-managed low-cost options, provided tracking errors are within limits.

Actively-managed funds

You may argue that index funds make no real sense when the equity market is on fire. Yours will not be a solitary voice, lots of people will swear by active management. After all, stocks have been advancing rapidly, and all manners of sectors are doing quite well. Why, then, should one consider index trackers at all? Aren't actively-managed schemes clearly the best options available? Don't active fund managers try hard to beat benchmarks (and their peers) in an effort to give superior returns?

The answers to these questions lie in the premise that index products can act as reliable props for a portfolio laden with equities. Remember, in the case of an actively-managed scheme, the fund manager concerned will face great risks when the market is declining. There is always the possibility of underperformance. An index fund, on the other hand, will neither under-perform nor over-perform; it will simply mirror the index that it has chosen.

All these arguments can be easily bunched together to arrive at a simple conclusion: There is a good case for index funds in this country. In fact, Indians should be more aware of these options and actually allocate more to them in times like these.

A number of index products are available at the moment, offered as they are by leading fund houses. Benchmark MF has rooted strongly for exchange-traded funds. A very special reference nevertheless can be made to Franklin India Index Tax Fund, which is probably one-of-a-kind in this country. This is actually a tax-saver (an ELSS, if you prefer) and tracks the 50-share Nifty. Launched in early 1996, it has given about 22 per cent since inception.

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