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Many investors look at starting their investment journey by investing in an index fund compared to an actively managed equity fund. Investors looking to invest in equity mutual funds but not confident about the abilities of the fund manager typically invest in index funds

1. What is an index fund?

An index fund is a type of mutual fund with a portfolio constructed to match or track the components of a market index, such as the Nifty or the Sensex. As each stock has different weightage in an index, the portfolio of an index fund is allocated in a way to mirror the index. For example, if HDFC Bank has a weightage of 5% in an index, a fund based on the index would also allocate 4% of its portfolio to the stock. An index mutual fund is said to provide broad market expo sure, low operating expenses and low portfolio turnover.

2. What are the types of index funds available in India?

You have index funds based on the Sensex and Nifty in India.

3. What are the advantages of index funds?

Index funds remove fund manager bias. There is always a chance that your fund manager may end up picking up a few underperforming stocks or the style of the fund could change after he quits. These situations could impact actively managed funds. Index funds negate this risk by passively investing only in securities that represent a particular index. Also since they are passively managed, their expense ratio is much lower than actively managed funds.

4. What the disadvantages of index funds? Why are they unpopular in India?

A fund manager brings with him a lot of experience and follows a structured investment approach. He analyses companies, meets managements regularly and based on real-time developments and trend analysis, he can take decisions that help a fund outperform. As per financial planners, actively managed funds have performed better than index funds in the past and they expect that to continue in the near future. A fund manager has the freedom to limit the downside by holding only performing securities, or going into cash if the need warrants. In case of index funds, they fall with the markets, since they have to stay invested in a non performing stock as well.

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