Does Index Fund Has An Edge Over Active Fund? Why Are They Gaining Popularity?

As many as 15 debt index funds were launched in October, highlighting their growing popularity and opportunities to create wealth in a high-rate situation.
Does Index Fund Has An Edge Over Active Fund? Why Are They Gaining Popularity?

The needle of investing is tilting more towards passive investments, as retail investors put in Rs 9,919 crore in index funds and exchange-traded funds (ETFs), while the inflow for actively managed funds stood at Rs 9,390 crore in October 2022.

Investments in actively managed equity mutual funds fell by 33 per cent month-on-month from Rs 14,099 crore in September, while passive instruments like index funds grew 119.03 per cent to Rs 5,075 crore from Rs 2,317 crore in the prior month.

The Passive Edge

Index funds are gaining traction as more and more fund houses have come up with such products. In October, a total of 21 new index fund schemes were launched, aimed at replicating the indices created by the National Stock Exchange (NSE), such as the Nifty Midcap 150 Momentum 50 or Nifty Smallcap 250.

Dhaval Kapadia, director at Morningstar , said various factors drive these funds, such as “valuation, quality, and momentum.” Kapadia said there are different ways to create a stock portfolio using these factors.

He further explains these factors are “back-tested on various groups of stocks. So, historically, if I use certain momentum filters, what is the result you would see.”

Also, since the expense of such funds is usually low, investors can use passive funds to create a well-diversified portfolio as per their risk appetite.

Typically, the expense ratio ranges from 0.1 per cent to 0.5 per cent, whereas in a passively managed fund, the expense ratio would begin at 0.5 per cent to 1.5 per cent, which is almost three times the expense ratio for the upper limit.

Moreover, index funds usually don’t have any exit load, which is levied by fund houses if one exits the fund in a certain period.

This gives index funds a massive edge over active funds. For some equity schemes, it is even higher and can go up to 2.50 per cent for a regular plan.

Passive Debt Instruments

Mutual fund houses launched 15 new debt index funds with varying maturity dates in October. Passive instruments are based on indices managed by CRISIL, India’s leading credit rating agency, and NSE.

“Many target maturity funds are launched, especially during this calendar year, given that interest rates have been moving up. Therefore, these funds are looking attractive. Target maturity, which looks at 3 to 7 years of maturity, invests in government securities, AAA papers, or state government securities,” Dhaval added.

These debt funds can be a compelling choice for investment as, unlike equities, where one has to look at various factors before investing, debt bonds have two main factors, credit rating and maturity date. CRISIL and NSE differentiate these indices based on their maturity date and then rank them according to their credit ratings.

You can choose the maturity date for your investment vehicle as per your risk appetite, as a higher maturity date has the risk of defaulting on the loan but will pay higher interest or return on your investment, whereas a bond with a lower maturity date will have a lower risk profile.

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