5 mins read . 08 Dec 2022
With fund managers the world over finding it tough to beat the indices, passive investing is taking off in a big way. Unlike an active fund, where fund managers try to select stocks that can outperform, passive investing is just about buying an index like the Nifty or Sensex. The passive fund does not try to beat the index returns but mirrors the index returns. That is not a bad idea, since the Sensex has given annualized returns of over 16.5% over the last 42 years, excluding dividends. Broadly, passive investing can be done through index funds or index ETFs (exchange traded funds).
Both index funds and index ETFs essentially try to mirror an index. Let us look at the index fund first. It is like any normal mutual fund, but the fund manager does not look for alpha (outperformance). Instead, they just create an index based portfolio that mirrors the index. The job of the fund manager here is to ensure that the tracking error (variation from index) is as low as possible. Index funds can be bought and redeemed through the AMC like any other open-ended mutual fund scheme.
Index ETFs are fractional shares of the index which are close-ended, and therefore, listed on the NSE/BSE. At the back-end, the ETF portfolio also mirrors the index. However, ETFs can be bought and sold like listed stocks at real time prices using your existing trading account. Such index ETFs can be held in the regular demat account along with other shares and securities. ETFs are much lower in cost and available on tap.
An index ETF and an index fund can be compared on the following parameters.
Both index funds and index ETFs are good ways to invest passively in the stock markets, with minimal alpha risks.