Index funds are in the limelight once again. They have outperformed all equity schemes, be it diversified or other funds. According to Value Research, mutual fund research firm, index schemes returned around 30% on an average in the last one year, while diversified equity schemes managed only 23% returns.
It is strongly believed that it is difficult to beat the index. It would be even more difficult in the future says an executive director of Benchmark MF, a fund house that specializes in index-based investment. When the market was going up, fund managers were investing in small-and mid-cap stocks to beat the index. Now that the tide has turned, they are trapped. Most diversified funds beat the index by long margins even last year. Fund manager at a private sector MF believes that they would do it again, when the market is on a run.
That is good news, but how about someone who wants to bet on an index fund? What are the advantages and what are the drawbacks. To begin with, Index funds are meant for passive investors, who want to bet on the marketâ€™s fortune. Index fundsâ€™ portfolio comprises stocks in a particular benchmark index like, say, the sensex or nifty.
Since the composition of the portfolio is similar to the benchmark index, even a small movement in the index would be mirrored in the net asset value (NAV) of the scheme. This way index funds allow the investor to be part of the fortunes of the stock market without any stock picking skills.
Looking at the benefits of investing in index funds they are cost effective. For example, if you are investing in a scheme based on, say, the sensex, you know you are investing in 30 shares that form the benchmark index. In that way, it is one of the most transparent investment avenues. This would also save you time, as you donâ€™t have to do any research. The investor donâ€™t have to bank on the stock picking skills of the fund manager, as all he has to do is buy index stocks in exact proportion.
If an investor has a one-year time horizon and is looking at investing in stocks, an index fund is the best investment option available to him today says a financial advisor. Once the market picks up, most of the action is likely to be in large cap stocks. Since index stocks are large cap stocks, an investor will benefit most from the trend.