Sucheta Dalal :Will index funds behave themselves?
Sucheta Dalal

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Will index funds behave themselves?  

April 28, 2010

The mutual fund industry seems to be waking up to the virtues of index investing. IDFC Mutual Fund is launching one and IDBI Mutual Fund is launching another. But index funds have not covered themselves with glory so far. Not only do index funds do not accurately track the movements of their underlying benchmark indices, leading to what is called tracking error, but some funds make nonsense of index funds by trying to actively manage such funds, when all they are supposed to do is passively follow the index. This gives rise to “outperformers” among index funds—a contradiction in terms.


HDFC Index Fund managed a return of 21.13% over 10 years when the Nifty has gone up 17.10%. ICICI Prudential Index Fund managed a return of 21.48% over eight years with growth in the Nifty at 20.15% and UTI Nifty Fund managed returns of 13.38% over 10 years with growth in the Nifty at 12.92%.

This outperformance could be partially due to an element of active management. To enhance returns, ICICI Prudential Index Fund invested 15.48% of Rs96.6 crore in the futures market on 31 March 2010. UTI Nifty Fund too has put some money in futures and bank deposits. This shows how index funds are trying to manage money actively to outperform the benchmark and show greater returns. They are also known to be trying to time the market, something that explains underperfomance (fund managers are bad at timing) leading to tracking error in some cases.


Among the index funds, LIC MF Index Fund recorded a return of 1.01% against 24.24% of the underlying index, leading to a tracking error of 23.23% as on 26th April. Birla Sun Life Index Fund recorded a return of 9.83% as against 25.06% return of the index, leading to an error of 15.23%. — Zeeshan Mardani

-- Sucheta Dalal