Today every social media financial expert is talking about Index funds. Index funds are low on expense and maintenance. Over the past few years there have been a lesser number of active large-cap funds that have beaten the index. For the ones beating the index, the margin of outperformance is reducing. Before the active fund managers were able to beat the benchmark indices easily.
Passive funds invest in the same stock which make up the underlying index. The proportion of the stock is also the same as the weight of the stock in the index. This gives a matching performance with the market and it will not try to outperform it.
It depends on the cycle in which you enter the market in the short to medium term. The higher returns may be because of a narrow rally in the market. It is quite likely that once there is a broad-based recovery in the markets, Nifty will outperform Sensex.
To choose one of these index funds is not an easy task. Clearly, the one giving more returns should be preferred.The main difference between the two is that Sensex keeps track of top 30 Indian companies and the Nifty the top 50. The daily movement of both indices show a slight difference but in the long run they are in sync. The expense ratio, tracking error and asset-size could be the crucial factors while choosing index funds. The one with the higher assets under management could be a good option. In case of redemption pressure higher AUM would be better.
Investing in both is again not a good option. It will fail to give any diversification. To have a large-cap index level exposure, choose any one. Any other index fund outside the top-30 or top-50 could be another option.
The problem with all kinds of index funds is that they suffer from concentration risk. An index might be more than comfortable in a few stocks or sectors. This will be taken into account by the index management committees in near future.
If the Sensex is made up of a lesser number of stocks then it is more concentrated. In case of a narrow rally in markets, it gives little better returns. But in a more broad based rally Nifty will be advantageous. In the long run it will not make any difference whether you invest in Sensex or in Nifty. As there will be intermittent phases of one index doing better the getting followed by the other.
Up to 1% tracking error is usually acceptable, that is, the difference between the fund’s and the index’s returns. For diversification purposes anywhere between 30-50 stocks are good. While making investments through an index fund, the investments are made based on the weight of the company.
Bhoi Smrutirekha Dharanidhar