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According to Value Research, a mutual fund tracking agency, the universe of equity funds, which consists 288 schemes, kept an average 6.76% of money in cash as on October 31. Of this, 35 schemes maintained more than 10% of the money in cash.
In such a scenario, if you want to invest in equity with no fund manager risk, index fund makes a good case for investment.
A simple example would drive home the point. We all known that the infrastructure sector has been down and out over the last couple of years. Lack of earnings visibility has marred the future of companies in this sector. However, experts are optimistic about the sector now and say the valuations are extremely attractive at the moment. In such a scenario, an infrastructure fund may be the choice of anyone wanting to invest in the infrastructure space. That is where the fund manager risk (he/she can fail to outperform the index) and wasted opportunity in the form of cash pile (five infrastructure schemes hold more than 10% in cash) come into play. To top it, some fund managers tend to invest in stocks that are not strictly 'infrastructure' stocks. Needless to say, an investor may not hit the jackpot in such a scenario even if there is a revival of fortunes of the infrastructure sector.
This is where sectoral index funds can come to the rescue of investors, according to index scheme enthusiasts. Look at the example of Goldman Sachs Infrastructure Exchange traded scheme, they say. It is an index fund that invests its corpus in infrastructure stocks in the same proportion as the CNX Infrastructure index. Like any other index fund, this fund would be fully invested to mimic the performance of the underlying index. This means the fund won't be investing outside the infrastructure universe, nor would it be sitting on a pile of cash in search of the right time or opportunities. In fact, the fund manager has invested 99.69% of the money in the index as on September 30. The annualised tracking error stood at 0.1% and the expense ratio is 1%. You can apply the same logic when it comes to selecting schemes in the other sectors, too.
Expense Ratio
Doing away with the fund manager risk is just one positive aspect of index funds.
Index fund is a low-cost vehicle to invest in equity and build long term wealth. Since the fund manager only has to mimic an index, there is not much churning of portfolio compared with an average actively managed diversified equity fund. This leads to lower costs. The cost incurred by a mutual fund is captured by the 'expense ratio' of the mutual fund. For example, IDFC Index Nifty Fund has the lowest expense ratio of 0.25%, followed by Reliance Index Nifty Fund with 0.4%.
Tracking Error
If all index funds tracking the same index are expected to offer the same returns, then it is obvious that one should pick the one with the least expense ratio. But don't look at this number in isolation, keep track of the tracking error, too. The returns generated by the index fund may deviate from the returns generated by the underlying index. This deviation from index returns, known as tracking error, should be minimum for a fund to be good.
The Right Index Fund
The next question is: which index fund you should invest in – sectoral, broad based or one that invests overseas? If you are looking for long-term wealth creation, invest in a fund that tracks a broad based index such as the Nifty or Sensex. A diversified equity index is expected to be representative of the economy and is expected to do well in a booming economy. A case in point is the BSE Sensex that has created wealth for investors over the last 20 years when it grew at a compounded rate of 15%.
However, if you think a particular sector has a brighter future, do invest in a sectoral index fund. And advocates of index fund assure that as the market becomes more mature, individual investors in India would have no option but to pick an index fund with lower expenses just like their counterparts abroad.
Needless to say, this claim is fiercely countered by many in the mutual fund industry. They argue that India is still a stock-picker's paradise and funds would continue to outperform their benchmarks. Index funds are less risky than the diversified equity funds and an investor can allocate some of his cash to such funds to reduce portfolio risk.
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Some of the Top performing Mutual Funds are
- HDFC Top 200 Fund
- ICICI Prudential Dynamic Plan
- DSP BlackRock Top 100 Fund
- Birla Sun Life Front Line Equity Fund
- Reliance Equity Opportunities Fund
- IDFC Premier Equity Fund
- SBI Magnum Contra Fund
- Sundaram Select Midcap
- UTI Dividend Yield Fund
