The markets have dipped sharply due to the global pandemic and there seems to be no respite soon enough, making investors anxious. Index funds are now being eyed to offer some relief.
As you may know, Index funds are passively managed funds. This implies that the fund does not attempt to outperform the benchmark index, it replicates the index. Index funds invest in the same companies as the benchmark index in the same proportion. The fund manager tries to build and match the portfolio whose holdings mirror the securities of a standard index. An index constitutes a representative collection of stocks that are important for the economy.
Index stocks are selected on a free-float basis and adjustments are made from time to time, keeping in view market conditions, market opportunities, applicable regulations, and economic factors. Stocks must be available for trading in the futures and options segment to be eligible for inclusion in an index. Besides, market capitalisation, liquidity, and trading frequency are other criteria.
Consequently, the fund moves in line with the benchmark index and duplicates the latter’s performance – upwards and downwards. If one ignores the tracking error, the performance of the index fund is a mirror image of the benchmark index.
Due to the ongoing situation, mutual fund houses have taken this as an opportunity to launch index-based funds, vying for a piece of the pie. Plus, investors are reluctant to bear any more risk for higher returns, preferring, instead, moderate returns in line with the benchmark index through passive management, i.e. in Index Funds.
Even L & T Mutual Fund intents to bank upon this lucrative opportunity and launched two Index funds:
- L&T Nifty 50 Index Fund is an open-ended equity scheme tracking NIFTY 50 Index
- L&T Nifty Next 50 Index Fund is an open-ended equity scheme tracking NIFTY NEXT 50 Index
The fund house points out in brief that investing in index funds makes sense now for the following reasons:
- Highly cost-efficient due to low total expense ratio.
- Diversified because it consists of top companies from across sectors in term of free-float market capitalisation.
- Free from fund manager’s biased error or inefficiency in terms of asset allocation
- Index funds seek to match the risk and return of the market, so no active risk of stock selection.
- Highly transparent as indices are pre-defined, investors know the sector, companies and proportion in which their money will be invested.
Both the schemes are open for subscription from March 24, 2020 to March 31, 2020.
What will the Investment strategy be?
As per the investment strategy, each of the funds will follow a passive investment strategy and invests predominantly in stocks constituting the underlying index in the same proportion as the index and endeavour to track the benchmark index. A very small portion (0-5% of the Net Assets) of the funds may be kept liquid to meet the liquidity and expense requirements.
The performance of the schemes may not be commensurate with the performance of the underlying index on any given day or over any given period. Such variations are commonly referred to as the tracking error. The funds intend to maintain a low tracking error by closely aligning the portfolio in line with the indices.
The stocks comprising the underlying index are periodically reviewed by Index Service Provider. A stock may be dropped, or new securities may be included as a constituent of the index. In such an event, the funds will endeavour to reallocate its portfolio, but the available investment/ disinvestment opportunities may not permit precise mirroring of the underlying index immediately.
Similarly, in the event of a constituent stock being demerged/merged/delisted from the exchange or due to a major corporate action in a constituent stock, the funds may have to reallocate the portfolio and seek to minimize the variation from the indices.
L &T Nifty 50 Index will be tracking the Nifty 50 Index that comprises of bluechip companies and has 41.5% of investments in financial service sector, followed by energy (13.66%) and IT sector (13.17%).
Image 1: Nifty 50 Top Sectoral Allocation
(Source: Nifty 50 index)
The top ten companies that are part of the flagship index are given in the table below:
Table 1: Top 10 holdings of Nifty 50
|Company’s name||Weight (%)|
|HDFC Bank Ltd.||11.0|
|Reliance Industries Ltd||9.28|
|Housing Development Finance Corporation||8.11|
|ICICI Bank Ltd.||6.95|
|Kotak Mahindra Bank Ltd||4.68|
|Tata Consultancy Services Ltd||4.54|
|Hindustan Unilever Ltd.||3.36|
|Axis Bank Ltd.||3.35|
Data as on February 28, 2020
(Source: Nifty 50 factsheet)
L&T Nifty Next 50 will track Nifty Next 50 index, which consists of stock number 51 to stock number 100 in market capitalisation. This category is believed to be the stepping stone to become part of Nifty 50 index. It has historically been a transition category for many companies that are leaders in their respective industries today.
Image 2: Nifty Next 50 Top Sectoral Allocation
(Source: Nifty next 50 index)
Most of the companies included in Nifty next 50 are 50 companies from NIFTY 100 after excluding the NIFTY 50 companies. And the top ten companies that are part of the index are given in the table below:
Table 2: Top 10 holding of Nifty Next 50
|Company’s name||Weight (%)|
|SBI Life Insurance Company Ltd.||4.51|
|HDFC Life Insurance Company Ltd||4.36|
|Shree Cement Ltd.||4.15|
|Dabur India Ltd.||3.84|
|Divi’s Laboratories Ltd.||3.68|
|Avenue Supermarts Ltd.||3.59|
|ICICI Lombard General Insurance Company Ltd||3.39|
|Pidilite Industries Ltd.||3.16|
|Godrej Consumer Products Ltd.||2.90|
|United Spirits Ltd.||2.80|
Data as on February 28, 2020
(Source: Nifty Next 50 factsheet)
L&T Nifty 50 Index Fund and L&T Nifty Next 50 Index Fund will be managed by Mr Parveen Ayathan. He holds a bachelor’s degree in Science with a specialisation in mathematics and has over 27 years of work experience.
Before joining L&T Asset Management Company in July 2012 as the Chief Dealer of equities, Mr Praveen headed the Equity Dealing domain at Kotak Mahindra Asset Management Company Limited for 7 years. And at the Dalal & Broacha stock broking Private Limited, he was the Institutional Head of Equity for 5 years.
Some of the schemes that Mr Praveen currently manages at the fund house include L&T Arbitrage Opportunities Fund, L&T Equity Savings Fund (Equity Component), and L&T Balanced Advantage Fund (Equity Component).
Index funds are good investment avenues for mature markets like the US, where to generate an Alpha is not possible because it has reached its stagnation. But for markets like India, there are opportunities for value buying, as government initiatives like ‘Make in India’ do provide room to various companies for growth and development.
Currently considering the markets conditions due to the pandemic, there are value buying opportunities in several midcaps and small caps, even some of the large caps are at their fair valuations.
In terms of performance however, actively managed Large-cap funds, Large & mid-cap fund, mid cap funds and multi-cap funds are better as compared to passive index funds, despite the short-term volatility.
Table 3: Average returns of index funds v/s market cap funds
|6 Month Return||1 Year Return||3 Year Return||5 Year Return||10 Year Return|
|Index – Nifty||-54.60||-26.57||-2.46||-0.13||6.22|
|Index – Nifty Next 50||-58.54||-28.88||-7.58||0.00|
|Index – Sensex||-51.29||-23.63||-0.48||0.75||6.80|
|Index Funds – Other||-58.61||-27.11||-6.04||-2.03||6.58|
|Market Cap funds|
|Large Cap Fund||-48.92||-23.01||-3.30||0.51||8.46|
|Large & Mid Cap||-51.89||-24.51||-4.62||0.83||10.16|
|Mid Cap Fund||-51.31||-26.50||-5.71||0.59||14.56|
|Multi Cap Fund||-49.60||-22.79||-4.40||0.36||10.10|
(Data as on March 26 2020)
(Source: ACE MF, PersonalFN Research)
Index funds are suitable for investors who want beta returns and are novice to investing in current times.
[Read: Best SIPs To Invest in 2019]
This article first appeared on PersonalFN here