| With equity markets surging sharply over the last 12 months, expectedly the performance of index funds has looked up as well. In fact the growth clocked by benchmark indices (and index funds alike) over this time frame has been so impressive, that quite a few diversified equity funds have failed to match them. Furthermore, index funds have been in the news for other reasons as well. Recently, the Securities and Exchange Board of India (SEBI) issued a notification to the effect that expenses charged on index funds would be capped at 1.50%. This makes index funds cost-effective investment options as compared to conventional diversified equity funds wherein the expenses that can be charged to the fund are capped at 2.50%. Index funds are typically associated with lower costs; this phenomenon is prevalent both globally and in the domestic mutual funds industry as well. The notification issued by SEBI will mean that now there is a regulation in place to ensure the aforementioned.
To sum up, there is a fair degree of investor interest in index funds at the moment and investors are evaluating the investment proposition offered by them. So should you invest in index funds? Before that, let's understand what index funds are and how they differ from diversified equity funds. Index funds are passively managed funds i.e. the fund manager attempts to mirror the performance of a benchmark index like the BSE Sensex or the S&P CNX Nifty, by being invested in the same stocks as the benchmark index and in the same allocation. This investment style is in contrast to the active management style that is pursued by diversified equity funds. In actively managed funds, the fund manager uses his expertise and skills to select stocks from across sectors and market segments in an unrestricted manner. To take this discussion further, now let's pitch index funds against some leading diversified equity funds and compare their performances across parameters. We have chosen the top-performing index funds over a 1-year period; conversely, diversified equity funds have been chosen based on their performance on risk and return parameters over longer time frames. From the index funds category, we have selected three funds i.e. ICICI Prudential Index and UTI Nifty Index, which have S&P CNX Nifty as the benchmark index and UTI Master Index which is benchmarked against the BSE Sensex.
(Standard Deviation highlights the element of risk associated with the fund. Sharpe Ratio is a measure of the returns offered by the fund vis-à-vis those offered by a risk-free instrument) Returns For example, over 1-year, ICICI Prudential Index ( 57.1%) emerges as the top performer, while DSP ML Opportunities (55.6%) comes in a close second. Over the 3-year period, all diversified equity funds have outperformed their index fund counterparts. It's the same story over the 5-year time frame as well, with diversified equity funds comprehensively outperforming the index funds. Volatility Risk-adjusted returns Expenses What should investors do? The trend is unlikely to be very different going forward. This is because Indian equity markets are still in a developing phase and therefore can offer enough investment opportunities (if identified earlier on) to outperform benchmark indices over the long-term. So, well-managed diversified equity funds ( i.e. actively managed funds) can be expected to score over index funds (i.e. passively managed funds), going forward as well. Hence it can be safely concluded that index funds don't make the grade as standalone investment avenues. Instead, investors' interests are likely to be better served by holding a portfolio comprised of well-managed diversified equity funds with proven track records across parameters and time frames. Index funds can feature therein (if required) in a smaller proportion and only from a diversification perspective. | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Should you invest in index funds?
