Index funds: Should you be investing in them? - Views on News from Equitymaster

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Index funds: Should you be investing in them?

Nov 7, 2001

As equity markets witness a surge, the index is finally showing encouraging signs of growth. Investors who had invested in index funds post-September will have seen an equal rise. The question is, should investors be taking fresh exposure to index funds.

There are several advantages of staying invested with index funds. First and foremost, with an index fund the investor has taken exposure to the best stocks in each sector, all bluechips and large caps. Moreover, there is no question of the fund underperforming the benchmark index simply because it is invested in it. The costs are also lower as unlike active funds, index funds save on the cost of hiring a professional money manager. Lower costs translate into higher returns.

The ideal time to invest in an index fund is when its at depressed levels. Its because from that level, the index can only go up, its only a question of when and not if. In our interview with Mr. Sanjay Sachdev, CEO and MD – IDBI-PRINCIPAL AMC, he underlined this point – ‘When the market is down and the index is languishing, it’s a no-brainer frankly. Index funds have the lowest expense ratio in the country and you are not relying on an active fund manager to invest for you. In the US mutual fund industry, Vanguard is ahead of even Fidelity largely due to their index products. An index fund is one of the best long-term investments. We know that the market (BSE Sensex) is at 3,200 points (in July 2001 when the was conducted) and it is going to go back to 4,000 points, all we don’t know is when and an index fund makes sense from that perspective.

However, not all investors may like the passive investment strategy of index funds. We asked Nitin Raheja (fund manager – equities SUN F&C Mutual Fund) whether he felt index funds would click in a big way in the country. To this he replied, ‘If you see the performance of equity funds since inception, you will find that most funds have beaten the index. While I agree that in the last year and a half, most equity funds haven’t performed well, however if you take a longer investment horizon, you will find that most funds have outperformed the index. Of course there will be funds that outperform the index and there will be funds that underperform the index. As the index is revamped at intervals to reflect the trends, it will possibly get more difficult to outperform the index. There will be a demand for index funds, because there could be a class of investors who would probably like to bet on the index for which purpose an index fund is the best option.’

So should you be investing in index funds now? The index (Sensex and S&C Nifty) is still pretty low right now and the potential to grow from here is tremendous. The only uncertainty is the period over which this growth will take place. Investors can invest small amounts in an index fund and can increase their investments at every fall. This way they will have averaged their cost effectively. When the index finally sees growth, they will be the ones to reap the richest rewards.

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