What is the difference between an index fund and an exchange traded fund (ETF)? Also, in the past, just a few diversified equity funds have been able to beat the market indices. Should I switch my investments from diversified equity funds to index funds?
- P C Chowdhury
Let us first, explain to you the difference between an index fund and an ETF.
An index fund is an open-ended fund that invests in securities which are part of a pre-determined index. The investment made is in identical proportion as that of the index. Like all other funds, an index fund is bought and sold through the fund house or its distributors at the previous day's closing net asset value (NAV). An index fund normally starts at a value of Rs 10 and then changes as the index changes.
On the other hand, ETFs are traded on a stock exchange so investors need to own a demat account and can buy or sell them through a broker. The value of an ETF is calculated as a fraction of the value of the index.
Let’s go with some examples. Benchmark Mutual Fund's BeES, the country's first ETF, tracks the S&P CNX Nifty Index. If you buy 1 Nifty BeES, you will own all the shares that make the Nifty in the same proportion as the index. Prudential ICICI's SPiCE is an ETF scheme that tracks the Sensex. While the BeES units trade at 1/10th of the Nifty value, SPiCE trades at 1/100th of the Sensex value. The index fund trades at the underlying value of the portfolio determined in its NAV, but an ETF scheme may trade at a premium or discount to its value, depending on the demand and supply in the market.
Now, we shall proceed to examine the other issue of the performance of diversified equity funds and index funds.
Index funds tend to be popular in an efficient market. This holds true in the U.S. and European markets. But a move towards a more efficient market in India would require greater long-term institutional participation as well as broader retail participation. Active fund management does have a role to play in India. Having said that, there were long periods (as in five years and more) when above 90 per cent of funds in India would beat the big indices consistently. As of now, there are still plenty of funds that beat the indices and by good margins, but their numbers are fewer and the list is not consistent.
This decision to shift your money into index funds will entirely depend on how much of risk you want to take. Also, probably the funds you invested in were not the right picks or you went in for a lump-sum investment when the market was on a high. Whatever your decision, here is a list of some index funds and ETFs.