Index funds are in vogue, but are they good value for money?  

April 29, 2010

An index mutual fund is constructed to match or track the components of a market index, such as the S&P CNX Nifty. Investing in an index fund is a form of passive investing which replicates a particular index. However, as we have highlighted yesterday, managers try to beat the market by actively managing the funds (http://www.moneylife.in/article/8/5098.html).

This either leaves them trailing the index or taking more risks to beat the index—when beating the index is not the job of managers running index funds. Most equity index funds fail to even match the returns of their respective benchmarks. One of the biggest disadvantages of index funds as they are run is the lack of transparency and the underlying ‘active management’.

In such a scenario, how can an investor be assured of returns of the index movements?

The best way out is to invest in exchange-traded funds (ETFs). ETFs are securities that track an index or a basket of assets like an index fund, but trade like a stock on an exchange. They experience price change throughout the day and can be traded in real-time. While index funds have to be purchased directly from a mutual fund, ETFs are bought from a stock broker. The Nifty BeES, an ETF that tracks the Nifty, can be freely bought and sold on the exchange, just like a stock.

Here is how Nifty BeES has done since inception. A buyer of Nifty BeES would have got a return of 21.63% compared to Nifty Index returns (its underlying index) of 21.74% from January 2002 till 31 March 2010. Nifty BeES has accurately tracked the movement of the Nifty Index year on year.

The corpus under Nifty BeES has sharply risen from Rs121.48 crore on 31 March 2009 to Rs603.30 crore on 31 March 2010, an astounding 397% increase in one year. As a result of this, Nifty BeES is a liquid traded product that can be bought and sold easily.

One of the biggest advantages of ETFs is that they are much cheaper than index funds. While index funds charge 1% as fund management fees and 1.5% as overall expenses, the charges for Nifty BeES are much lower—just 0.5% as fund management fees and the usual charges of brokerage and demat.

There are other exchange-traded funds such as ICICI SENSEX Prudential Exchange Traded Fund launched in January 2003, Bank BeES Launched in 2004, Kotak Sensex ETF launched in 2008 and the Kotak Nifty ETF launched recently in 2010. The problem with these is that they are thinly traded and so the bid/ask price is wide. But once they gain volumes, these would be ideal products to buy and hold for the average investor.— Zeeshan Mardani