Index funds: Going beyond popular benchmark indices

With actively-managed mutual funds finding it increasingly difficult to generate an excess return over benchmarks, the volume of index fund launches has picked up pace in recent times.

HDFC Mutual Fund has unveiled three offerings — a NIFTY Midcap 150 Index Fund, a NIFTY Smallcap 250 Index Fund, and an S&P BSE 500 Index Fund.

While equity index schemes earlier used to be centred around Nifty and Senex, the index fund universe has expanded to include different market capitalisation-based index products, and sectoral products.

Here’s a detailed look at the entire bouquet of offerings, and their pros and cons.

The equity index fund segment manages investor assets of about ₹52,000 crore across 87 products (with at least 3-month NAV history), according to ACE MF data.

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The biggest pocket (41) in the equity index funds belongs to largecap schemes i.e funds based on Nifty 50, Sensex, Nifty Next 50 (50 companies from Nifty after excluding Nifty 50), and Nifty 100.

Excluding the 25 largecap index funds that track Nifty 50 and Sensex, the balance (13) is based on Nifty Next 50 and Nifty 100 (3). These are offerings that help you go beyond the popular benchmark indices.

Nifty Next 50, Nifty 100

Nifty Next 50 index funds invest your money in the portfolio of 50 large-cap companies which may have the potential to become mega-caps of tomorrow.

You get to invest in an index that provides exposure to a wide range of businesses across sectors as compared to the Nifty 50 index, with lower concentration risk. Nifty Next 50 index comes with higher volatility and this could mean extended periods of underperformance.

In terms of returns, Nifty Next 50 index fund returns in the 1-year range between -11.5 to -12.2 per cent, in the 3-year range between +17.9 per cent to + 18.7 per cent (CAGR), and 5-year are around +4.9 per cent (CAGR).

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Direct plan expense ratios fall in the 0.1-0.3 per cent range. We prefer ICICI Pru Nifty Next 50 Index Fund, UTI Nifty Next 50 Index Fund, and SBI Nifty Next 50 Index Fund for their relatively higher asset base, decent tracking errors, and reasonable expense ratios.

Nifty 100 essentially captures the entire largecap universe in the market because it combines Nifty 50 and Nifty Next 50. Besides, the Nifty 100 offers a good way to get exposure to the Nifty Next 50 stocks, with lower volatility.

The weights of the Nifty 50 and the Nifty Next 50 companies in the Nifty 100 combined index are different. Since Nifty 100 is a market-cap-weighted index, so significantly-larger Nifty 50 companies get a higher total weight in the index.

The three options in the Nifty 100 index fund come from Axis, HDFC, and Bandhan, but none has a 5-year history. Direct plan expense ratios are in the 0.1-0.3 per cent range. In terms of returns, Nifty 100 index funds have fallen -3.1 per cent to -3.5 per cent in 1 year while the 3-year return of the lone fund is 23 per cent (CAGR).

Different m-cap offerings

Besides large-cap index funds, investors today have access to large and midcap schemes, mid-cap schemes, small-cap schemes, and broader m-cap schemes (tracking Nifty 500).

On the pure mid-cap index segment, there are over half a dozen choices. Mid-cap index funds are much more volatile compared to large-cap indices and can from time to time witness large drawdowns due to mid-cap stocks. Note that mid-cap index funds offer higher rewards and higher risks. None of the mid-cap index funds have completed five years.

Most of these index funds track Nifty Midcap 150 basket. In terms of returns, 1-year returns range between -1.3 to -1.6 per cent and the 3-year return of the lone fund is +33.1 per cent (CAGR). Direct plans cost 0.1-0.4 per cent. We prefer Motilal Oswal Nifty Midcap 150 Index Fund and Nippon India Nifty Midcap 150 Index Fund.

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On the small-cap side, there are again over half a dozen options. For an investor holding Nifty 50 and Nifty Next 50 index funds, smallcap index funds may seem exciting on account of deeper market exposure. But do note the small-cap segment is filled with smaller businesses that pale in comparison to larger peers.

The highest return potential available in small-caps is due to the inherent risks. The impact costs are quite high in small-caps, so NAV volatility can occur during market distortion phases.

All the small-cap index funds track Nifty Smallcap 250 Index. One-year returns fall between -9.4 per cent to -9.8 per cent while the 3-year return for the lone fund is +36.7 per cent (CAGR). Direct plans cost 0.3-0.4 per cent. We prefer Motilal Oswal Nifty Smallcap 250 Index Fund and Nippon India Nifty Smallcap 250 Index Fund.

In the large and midcap space, you have just one relatively new scheme: Edelweiss Nifty Large Mid Cap 250 Index Fund (direct plan cost 0.38 per cent). This index offers a blend of large-cap and mid-cap stocks exposure in one single portfolio.

In terms of multi-cap play, Motilal Oswal Nifty 500 Index Fund (costs 0.4 per cent) offers a route for investors looking to invest in Indian markets across large-, mid-, and small-cap stocks. Such an index tends to have higher coverage of the listed universe, higher coverage of sectors, and lower concentration risks. On the flip side, with 500 stocks in the index, the tail is rather too long.

Sectoral bets

There are six sectoral index funds that cover banking, financials, auto and pharma. For pure-play concentrated banking exposure, Nifty Bank offers a clean route and this is available in Motilal Oswal Nifty Bank Index Fund, Navi Nifty Bank Index Fund, and ICICI Pru Nifty Bank Index Fund. Direct plans cost 0.1-0.2 per cent.

But for those looking for a way to bet on financials excluding banking given the existing high weight of the sector in all portfolios, there is Motilal Oswal S&P BSE Financials ex Bank 30 Index Fund (less than 1-year history, direct plan costs 0.3 per cent).

Sectors such as auto (ICICI Pru Nifty Auto Index Fund) and pharma (ICICI Pru Nifty Pharma Index Fund) are also available for taking concentrated sector bets. Direct plans cost about 0.3-0.4 per cent.

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