What are index funds

Index fund is an instrument which invests in the basket of securities that, replicates the composition of a market index, like Nifty, Sensex, Bank Nifty, CNX 100, CNX Midcap, Gold ETF, Nifty CPSE etc. Like any other equity mutual fund scheme, index funds are also managed by Asset Management Companies (AMCs). However, unlike different equity fund categories, fund manager of an index fund do not aim to beat the benchmark index. The primary objective of an index fund manager is to reduce the tracking error with respect to the index against which it is benchmarked.

Index funds give investors the opportunity to invest in an index fund without having to worry about trading margins and marked to market losses. You can hold your index fund as you would hold any other mutual fund scheme for as long as you want to benefit from the long term capital appreciation.

Even though different equity mutual fund schemes aim to diversify unsystematic risks (or security specific risk), and they do diversify, to a large extent depending upon the category of the scheme or theme/ sector of the mutual fund scheme, there is likely to be still some residual unsystematic risk in these equity mutual funds.

The equity fund manager can be overweight or underweight on certain sectors or stocks relative to the index, in their attempt to beat the index or category returns. Since equity mutual fund portfolios do not exactly reflect the benchmark portfolio composition, there is likely to be some unsystematic risk (company and sector risks) in addition to systematic risk (market risk). Index funds, on the other hand, are only subject to market risk, since they reflect the market portfolio.

You may know the names of few Index funds which are given below. Please check these links and know more about these ETF Funds -

Kotak Nifty ETF

Kotak Sensex ETF

Reliance ETF NIFTY 100

Reliance ETF NIFTY BeEs

ICICI Prudential NIFTY Next 50 Index Fund

Since index funds are passively managed, the expense ratios of index funds are much lower than actively managed equity mutual fund schemes. Investors who are looking for market returns at a low cost over a long investment horizon should invest in Index Funds.However, you should note that, since index funds are passively managed they may underperform versus top performing actively managed equity funds in the long term.

Read What are Equity Mutual Funds in India and their various types