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Index funds can give you wide exposure--at low costs. By Dhirendra Kumar
Not only does the portfolio of such a scheme consist of only the stocks that make up an index, it is even weighted in exactly the same ratio. Since index fund schemes mechanically track an index, instead of choosing shares that may or may not outperform it, they simply buy all the shares in a given index. Thus, the performance of an index scheme will always mirror that of the index, faring neither worse nor better than, on an average, the stockmarket. That's why they are equated with robots, with the fund-managers being described as black-box managers since they merely program a computer to buy shares in proportion to an index as it changes. You could discount the bit about novelty since the Unit Trust of India manages the India Index Fund -- which mirrors the National Stock Exchange Index (Nifty) -- but that is open only to the dollar investor. Back home, at least four index funds are likely to be launched in this financial year. Already, JM Mutual Fund has announced its JM Index Fund, which boasts of two variants: while Plan A will track the 30-share Bombay Stock Exchange Sensitivity Index (BSE Sensex), Plan B will track the 50-share Nifty. Investors who believe in the theory of efficient markets favour index funds on the assumption that any attempt to beat the market is an exercise in futility in the long run. If you ask me, tracker funds are relevant in some stockmarkets -- not all. My evidence suggests that the more mature the stockmarket, the more difficult it is to add value to a portfolio. That's because, in such markets, the information fund-managers receive is the same as everybody else. So, unless he is taking big sectoral or stock bets, any fund-manager will only underperform the index. Our stockmarkets are fast gaining maturity, and beating the market is, increasingly, becoming difficult. And they also seem to satisfy the other pre-requisite for an index fund scheme: liquidity, since the stocks in the indices at least are pretty liquid. However, such a scheme will only work as long as everybody is analysing all the companies listed in the stockmarket, which must also set fair prices for scrips. That's because an index fund scheme does not recognise the performance of a company, but simply goes by its weightage in the index. If the weightage of a scrip goes up in the index, the scheme will buy more of it to maintain parity -- and vice-versa. For example, if X is heading for a disaster, all the active fund-managers in the stockmarket will start selling it while the scheme will just keep buying it if it gets new money. And if X does go bust, it will just write it out of its portfolio. How efficient our stockmarkets really are is also rather debatable. Hopefully, with the recent emergence of a new breed of professional fund-managers, the day of the index fund scheme may just have arrived in this country. |
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Soon, the robot-schemes will be here.
Otherwise known as index fund schemes, they -- as their very name suggests -- hitch their
fortunes to those of a stockmarket index. 