Index investing is a relatively new concept in India. However, it is also a fast-growing mutual fund category, according to the monthly mutual fund inflow data published by the Association of Mutual Funds in India (AMFI). These funds track a specific benchmark index and are hence known as index funds. The weight of securities that make an index fund scheme portfolio is the same as represented on a specific index.
For instance, a company representing 5% of the BSE SENSEX could be replicated by a 5% representation in the corresponding index fund. Index funds offer a simple way to get long-term returns, providing an opportunity to beat inflation and grow your wealth.
In this article, let’s discover the different types of index funds and learn how each can fit into your investment strategy for long term growth
Types of Index Funds for Long-term Investment
Companies that maintain stock market indices are responsible for determining the type of indices and their constituents. In India, BSE and NSE, the two premier stock exchanges, have set up two step-down subsidiaries or joint ventures. They do a periodic review of the indices like the BSE Sensex or NSE Nifty. Then, there are broader indices like BSE 200, NSE 500 or sectoral indices like BSE FMCG index or the Nifty IT index.
Here's a breakdown of the index funds categories for long-term growth.
- Broad Market Index Funds
A broad market index is a compilation of large and liquid stocks listed on the stock market, and an index fund mimicking the performance of any such index is a Broad Market Index Funds. For example, the BSE 500 and Nifty 500 indices cover a broad spectrum of stocks, including large, mid-cap, and small-cap companies. As an investor, you gain immediate access to a diverse array of shares across various sectors.
Examples
- BSE Sensex Index Funds: These funds track the BSE Sensex, which includes 30 of the largest and most actively traded companies on the Bombay Stock Exchange. It's a good choice for those looking for broad exposure to large-cap stocks.
Nifty 50 Index Funds: These funds track the Nifty 50, which includes 50 major companies listed on the NSE. It offers diversified exposure across various sectors.
- Market Capitalisation Index Fund
Market capitalisation, or market cap, refers to the total value of a company which is calculated by multiplying the total number of shares by the current market price per share. So, a Market Cap Index Fund provides an opportunity to invest in a company's securities based on its market value within an index.
Examples
- Large-Cap Index Funds: These funds are invested in large-cap companies and well-established firms with high market capitalisations. They tend to be less volatile and offer potentially stable returns than other market-cap companies. They are the funds that track major indices like the NIFTY 50, SENSEX, NIFTY Next 50, and NIFTY 100. Index funds are known for their low costs as they mirror the performance of these established indices.
- Mid-Cap Index Funds: These funds focus on mid-sized companies with moderate market capitalisations. They strive to strike a balance between risk and reward, potentially offering higher growth compared to large-cap stocks. For instance, a Nifty Midcap 150 Index Fund tracks the Nifty Midcap 150 Index that includes the next 150 companies (ranked 101-250) based on market capitalisation from the Nifty 500. This index measures the performance of mid-cap companies.
Small-Cap Index Funds: These funds target smaller companies with lower market capitalisations. While they might come with higher risk, they may also offer a chance for substantial long-term growth. An example is a Nifty Small-cap 50 Index Fund, which tracks the Nifty Small-cap 50 Index, capturing the performance of the small-cap segment of the market.
- Large-Cap Index Funds: These funds are invested in large-cap companies and well-established firms with high market capitalisations. They tend to be less volatile and offer potentially stable returns than other market-cap companies. They are the funds that track major indices like the NIFTY 50, SENSEX, NIFTY Next 50, and NIFTY 100. Index funds are known for their low costs as they mirror the performance of these established indices.
Sectoral Index Funds
These funds are designed to track specific sectors, so you can invest in industries like automobiles, technology, FMCG, healthcare, or media, depending on the scheme you choose. This approach lets you tap into potential growth in a sector without worrying about picking individual stocks.Examples
- Nifty Bank Index Funds: These funds invest in stocks from the banking sector within the Nifty index. They are ideal for those who are bullish on the long-term prospects of the banking industry.
Nifty IT Index Funds These funds focus on the IT sector, investing in technology stocks within the Nifty index. Suitable for those looking to capitalise on India's IT sector growth.
- Nifty Bank Index Funds: These funds invest in stocks from the banking sector within the Nifty index. They are ideal for those who are bullish on the long-term prospects of the banking industry.
Thematic Index Funds
Thematic Index Funds focus on specific investment themes. The market exposure is dictated according to the chosen theme to make the most of prevalent market trends. The fund allows you to invest across various sectors as long as it follows their chosen theme. Examples of these themes include infrastructure, ESG (Environmental, Social, and Governance), travel and tourism, and more.
Example
Nifty India Tourism Index Fund:
This Index Fund focuses on the tourism theme and tracks maximum of 30 stocks from the index, Nifty 500. The weight of each stock in the index is determined by its free float market capitalisation. It includes stocks related to travel and tourism, such as hotels and resorts, travel services, restaurants, airlines, and airport services. Additionally, it may feature companies that produce travel essentials like trolley bags, suitcases, and luggage.
Strategy Index Funds
Just like Thematic Index Funds, Strategy Index Funds focus on a particular investment strategy. Strategy Index Funds replicate indices created using quantitative models and specific investment strategies. This category also includes Smart Beta Index Funds, which are also known as factor-based indices. These funds track indices where the weightage of companies is determined by factors such as quality, value, volatility, growth, and momentum.
Examples
- Nifty100 Equal Weight Index Fund: This Index Fund aims to mimic the investment strategy of the Nifty100 Equal Weight Index. The Nifty100 Equal Weight Index includes the same companies found in the Nifty 100 Index, which combines the Nifty 50 and Nifty Next 50 indices. However, unlike other indices, each stock in the Nifty100 Equal Weight Index gets the same weight during regular updates (quarterly and semi-annually).
Nifty Alpha Low Volatility 30 Index Fund: This fund tracks the Nifty Alpha Low Volatility 30 Index, which features a portfolio selected for its high alpha and low volatility. This index aims to reduce the fluctuations typical of single-factor strategies and offers you exposure to multiple factors through a single index.
International Index Funds
These funds give you access to global markets, helping you diversify your portfolio and reduce the risk of focusing too much on one region. They also include securities from governments and companies around the globe.
Example
NASDAQ 100 Index Fund: This Fund aims to closely match the performance of the NASDAQ 100 Index. This index tracks the performance of the 100 largest non-financial US companies listed on the Nasdaq Stock Exchange. As an Indian investor, this fund gives you an opportunity to invest in US stocks.
Debt Index Funds
Bond or Debt Index Funds aim to replicate the performance of a fixed-income index. These funds provide exposure to a variety of fixed-income securities, including government bonds, municipal bonds, and other debt instruments, without the need to select individual bonds.
Example
Nifty G-Sec Dec 2029 Index Fund: This fund aims to track the Nifty G-Sec Dec 2029 Index, which measures the performance of government securities (G-Secs) maturing within the twelve-month period ending December 31, 2029.
Custom Index Funds
Custom index funds provide complete flexibility based on your investment goals. They follow a personalised index that fits your strategy. You can choose which sectors to include or exclude and set specific criteria, so the portfolio reflects your personal investment preferences.
Reasons Why Index Funds Are Ideal for Long-Term Investments
All the funds mentioned above have the potential to deliver long-term growth. Here are the reasons why:
- Diversification: The index funds that track broad market indices, helps to spread your investments across many companies and sectors. This reduces your risk by minimising the impact of any single stock’s poor performance over time. Moreover, with time, as performances of sectors and companies improve, the positive change reflects in your investments as well.
- Lower Costs: These funds are passively managed, which means lower fees compared to actively managed funds. This may help improve your long-term returns by minimising expenses.
- Performance linked to index: These funds aim to match the performance of their benchmark index.
- Long-Term Growth: These funds benefit from compounding growth. This means your returns generate further returns, leading to significant growth over the long term.
- Reduced Emotional Investing: By following a set index, you’re less likely to make emotional decisions based on market fluctuations, helping you stick to a steady long-term strategy.
Conclusion
Index funds may be a valuable addition to your portfolio. They are a low-cost efficient vehicle to invest across different asset classes. Given the sheer variety of index funds available, it's crucial to understand what they mean and how they work for you. Consider your risk appetite and investment objectives before investing just like any other asset class.
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