Mutual Funds

Should you buy Index funds now?

Parvatha Vardhini C | Updated on March 26, 2020 Published on March 26, 2020

NFOs of L&T MF’s Nifty 50 and Nifty Next 50 Index funds are open for subscription

With valuations of many bluechip stocks correcting sharply in the market crash, opportunities abound. But if you think buying individual stocks is a risky affair, one way to cash in on the fall could be to invest in funds that mimic the large-cap indices.

This seems to be the rationale behind the new fund offer (NFO) of L&T Mutual Fund’s Nifty 50 and Nifty Next 50 index funds. The offer is open until March 31. Like any open-ended fund, it will reopen for investment later. But this is not the only fund mirroring these indices and a handful of them is already available.

 

Why now?

In the market fall that began since February 20, the Nifty 50 and the Nifty next 50 indices have corrected by 31-32 per cent. Many stocks that are part of these indices have fared worse than the indices in this period, while some others have fared much better.

With Covid-19 fears continuing to bog down markets and economies across the globe, one can never be sure if the worst is over. If you don’t have the risk appetite to buy individual stocks, you could consider index funds. New investors looking to enter the markets now can also consider the index fund route as it diversifies the risk.

Strategy

The Nifty 50 and Nifty Next 50 indices complement each other. While the Nifty 50 comprises the top 50 stocks based on free float market capitalisation, the Nifty Next 50 comprises 50 companies from the Nifty 100 after excluding the Nifty 50 companies. In other words, the Nifty Next 50 index represents companies that have the potential to be future bluechips. These companies could be a good via media between higher risk mid-cap stocks and bellwether stocks.

Sectors such as financial services, information technology and energy are the top three in terms of weight in the Nifty 50 index. Though financial services figures in the top three sectors for the Nifty Next 50 as well, the weightage is tilted more towards defensive sectors such as consumer goods and pharma, which fall in the second and third places.

However, it is not necessary to play this theme with new funds. At present, there are already 15 index funds based on Nifty 50 and five funds based on the Nifty Next 50 in the market with those from DSP MF and Motilal Oswal MF being recent entrants in both the categories. Funds with a track record of five years, least tracking error and lower expense ratios include UTI Nifty Index Fund, HDFC Index Fund – Nifty 50 Plan and ICICI Pru Nifty Next 50 Index Fund.

Index funds vs large-cap funds

The case for choosing index funds mirroring large-cap indices has grown stronger, considering that the average returns of actively managed large-cap oriented funds have trailed these indices over long time frames. Over three- and five-year periods, for instance, the Nifty 50 TRI and the Nifty 100 TRI have outperformed the average returns of large-cap funds by 1-2 percentage points.

On rolling returns, calculated on the basis of last 7 years NAV history, the performance of the Nifty 50 TRI is on par with the average of large-cap funds in three- and five-year periods, while the Nifty 100 TRI has marginally outperformed the large-cap funds average in the same time frames. Besides, on a rolling return basis, the returns of the Nifty Next 50 TRI are better than average of large and midcap, and multicap categories by up to 3.5 percentage points over three- and five years.

Actively managed large-cap funds, though, cannot be entirely written off. While average returns have lagged behind, some of the better managed funds have posted superior returns. However, if you want equity market exposure but have a relatively medium risk appetite, index funds can be a good addition to your portfolio.

Index funds vs ETFs

Index funds score over the other category of passive funds — Exchange Traded Funds (ETFs) — too, on a few counts. One, if you are new to stock market investing and are taking the index fund route, you need not fret about not having a Demat account. While ETF investing requires one, index funds, like other categories of mutual funds, are directly bought and sold from the fund house. With index funds, you can take the SIP route. But that is not possible with ETFs.

Thirdly, as ETFs are listed on the stock exchange, they may face liquidity issues when buying and selling if they are thinly traded. As a result, there could be a divergence between the price and the NAV. Index funds don’t face these problems.

Where index funds score

 

Better than large-cap funds over long periods

Low cost

No demat account required

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    Published on March 26, 2020
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