What are Index funds and Exchange Traded Funds?

Author : Quantum AMC | Published On : 26 Apr 2021

How do Index funds work?

According to the portfolio aligned with the Index, the fund manager buys or sells units according to the portfolio during any changes in the stock's weight within the Index.  Although it is easier to follow passively managed funds, there is a limitation to this it may not always offer the same returns as that of the Index because of an error called tracking error and scheme expenses. Tracking error occurs due to disproportionate holdings of securities that align with the Index and transaction costs incurred.

Understanding Nifty Index Fund

Nifty Index funds are also a replica of Index funds. Nifty Index funds in India are those mutual funds that are a replica of the composition of nifty stock indices. So you may choose to invest in a set of handpicked instead of restricting yourself to a particular stock. The Nifty Index fund is a replica of the NSE Index, which is a benchmark

Hypothetically speaking, Nifty 50 has around 31% exposure to the Retail/FMCG Industry. Thus, Nifty Index funds that track Nifty 50 will also have 31% of its portfolio invested in the Retail/FMCG sector. The same stocks that are included in the benchmark Index are easier to track and analyze. Nifty Index funds gives you the best of both worlds with the benefit of Indexation and optimum use of marketization of stocks.

Benefits of Investing in Nifty Index funds in India

  • Risk-adjusted returns: Nifty Index fund gives you the benefit of reduced risk level for those who do not wish for an actively managed fund. Investors should remain invested in Nifty Index fund for at least 3-5 years to generate risk-adjusted returns.
  • Invest in a basket of shares: Allows you to own the shares in the Index for a fraction of their value in the Index.
  • Diversification: This allows you to diversify across the top companies in different sectors through a single investment.
  • Returns in tandem with broad market average: Nifty Index fund is an easy and feasible investment avenue to lock returns in line with the benchmark Index, which means that investors are in tune with the broad market at all times.
  • Flexibility: Gives you the flexibility to choose between nifty Index direct growth and indirect option.

What are Exchange-traded funds (ETFs)

Exchange-traded fund (ETF) is a type of investment that can trade on an exchange like a stock, which means they can be bought and sold throughout the trading day. From traditional investments to tangible assets like commodities or currencies are offered by ETFs.

Let’s understand the types of ETFs:

There are a few types of ETFs like –

  1. Market ETFs – includes Index S&P 500
  2. Bond ETFs – This is designed to provide exposure to various types of bonds available; corporate, high-yield etc.
  3. Sector/ industry & Commodity ETFs: Designed to provide exposure to a particular industry, such as oil, pharmaceuticals, or commodities.
  4. Style ETFs – This is based on investing style or pattern such as growth stock or small cap equities.
  5. Actively managed ETFs are curated to outperform an Index, unlike most ETFs, which track an Index. 

There are a few more ETFs in the market that can be classified based on strategy.

  • In short, ETFs are easy to trade - you can buy and sell any time of the day

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Mutual Fund investments are subject to market risks, read all scheme related documents carefully.