The Hindu Business Line : Inverse index funds

Consider this: My friend has unrealised gains of 40 per cent generated over the last six months. He wants to protect his profits from the recent market volatility without selling his investments. My friend has been advised to buy inverse index funds to fulfil his objectives. What are inverse index funds?

A typical index fund will move in the same direction as its benchmark index. A Nifty Index Fund, for instance, will move up nearly 5 per cent if the Nifty Index moves up 5 per cent.

An inverse index fund will generate returns that will move in the opposite direction to the benchmark index. If Nifty were to move down 5 per cent, the inverse index fund will move up by nearly as much. In effect, an inverse index fund gives you a short exposure to the broad market movement through a long position. Does that sound confusing?

When you expect a stock to go down, you sell the shares hoping to buy them back at a lower price (short-selling). But, if you are like most others, shorting may not be your cup of tea. After all, it is not easy to convince ourselves to sell something that we do not own in the first place.

An inverse index fund helps you get over such feelings. You simply buy (go long) the fund if you want to profit from a market decline.

An inverse index fund could be used as a hedge to your existing portfolio. The flip side is that the fund will lose money if the index moves up! This concept was popularised in the US by Rydex Funds. Benchmark Mutual and some others propose to introduce such funds in India.

(The author is based in Toronto, Canada.)