What are index funds?

What is market index?

Market benchmark indices created to measure and track performance of different asset categories and sub-categories. In equities for example, we have indices for Bluechip stocks (e.g. BSE Sensex, Nifty 50), Large caps e.g. Nifty 100, Midcap stocks e.g. Nifty Midcaps 150 etc, Small caps stocks e.g. Nifty Small Cap 250 etc, broader market Nifty 500 etc. Likewise, we also have indices for various fixed income asset categories. These indices are constructed and maintained by different stock exchanges, where these securities are traded.

What are passive funds?

What is an Index Fund - Passive funds track different market indices e.g. Nifty 50, Sensex etc. Unlikely actively managed mutual fund schemes, passive funds like Index Funds do not aim to beat the index. The total expense ratio (TER) of passive funds is much lower than actively managed funds. Index Funds are examples of passive funds. Passive Funds have been gaining popularity globally, over the last several decades. In the last few years, passive funds have also garnered a lot of interest in India.

What are index funds?

New investor may want to know Index funds meaning. Index Funds are passive mutual fund schemes which track an index. ETFs invest in a basket of stocks which replicate the index the fund is tracking; the percentage weight of stocks in an index funds is the same as the percentage of the stocks in the market benchmark index. You can invest in index funds just like any other mutual fund scheme.

Benefits of Index Funds

• The biggest advantage of index funds is low cost. The expense ratios of index funds are much lower than actively managed mutual funds. For the same level of performance of the underlying portfolio, lower costs means high returns for investors.
• As a financial market becomes more efficient, it leads to faster price discovery and it becomes more difficult for fund managers in some market segments, to generate alphas (beat the market) in the long term by investing in under-valued stocks.
• If the fund manager of an active scheme finds it difficult to beat the market, then lower costs of index funds work to its advantage.
• Actively managed funds aim to beat the market benchmark index. In order to beat the market index, they need to be overweight / underweight on some stocks / sectors. This gives rise to unsystematic risk i.e. stock or sector specific risk in actively managed funds.
• There is no unsystematic risk in index funds because they invest in the entire basket of stocks in the index they are tracking, in the same proportion as the market index. Index funds are only exposed to market risks.
• Index funds which track market cap weighted indices (most market indices are market cap weighted) give higher weights to strong performers and lower weights to poor performers in their basket of securities because that is how market cap weighted indices work. This results in superior investment returns

Difference between Index Funds vs mutual funds

Let us see the difference between index fund and mutual fund. While Index Funds are passive schemes, the regular mutual funds are actively managed schemes. If you can understand mutual vs index fund difference, you can make an informed investment decision. Please see the table below.

How to select index funds?

We have discussed what are index funds and what index fund meaning is. We also discussed how to purchase index funds. But you should know the following whether you are investing in actively managed funds or Index funds:-

• Know your investment goal and risk appetite. Consult with your financial advisor, if you need help in understanding your risk appetite.
• Select the appropriate market index whose risk profile matches with your risk appetite. You should know that, different market indices represent different asset categories / sub-categories with different risk profiles. Consult with your financial advisor if you need any help.
• Select an index fund with low TER. You will find the TER of an index fund in the monthly fund factsheet. Lower the TER, higher will be the fund’s performance relative to other index funds tracking the same index.
• Select a fund with low tracking errors i.e. deviations of fund returns from index returns. TER is often a major source of tracking errors. However, there may be other sources of tracking errors. You may find tracking errors in the fund factsheet.

Consult your financial advisor, if you want to know further what's an index fund and take his/her any help in selecting which index fund will be suitable for your investment needs.

An Investor Education and Awareness Initiative by Mirae Asset Mutual Fund.
For information on one-time KYC (Know Your Customer) process, Registered Mutual Funds and procedure to lodge a complaint in case of any grievance Click Here.

Mutual Fund investments are subject to market risks, read all scheme related documents carefully.