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Index funds go out of favour

Apr 9, 2001

The decline in equity markets has made the index fund investor anxious. They have realised that passively managed funds offer little relief (vis-à-vis actively managed funds) on a downturn.

Index funds advocate the philosophy of passive investing. 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 exactly the same proportion. 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 that of the benchmark index.

UTI-MASTER INDEX 10.6 -5.9% -10.9% -26.2% 6.7%
UTI NIFTY INDEX 6.8 -5.9% -11.2% -20.9% -26.9%
FRANKLIN INDIA INDEX 8.6 -0.6% -11.4% 0.0% -12.8%
IDBI-PRIN INDEX 8.7 -0.7% -11.9% -21.8% -9.9%

Given the performance of equity markets over the last few weeks, investors in index funds are getting increasingly jittery. At least actively managed funds can reduce exposure to infotech stocks in their portfolio, but index funds have to necessarily maintain the required allocation to infotech stocks in the benchmark index. For instance, currently (as on April 9, 2001) total infotech allocation in the S&P CNX Nifty is 12.4%. An Index fund has to necessarily have this much exposure to infotech in exactly the same stocks as S&P CNX Nifty in the same proportion. However, an active fund manager can reduce exposure to infotech considering the negative sentiment in the sector currently.

In a falling market an index fund can prove risky as fund managers are not at liberty to reduce exposure to falling stocks. In a bear market, actively managed funds are a safer bet.

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