Looking to invest in index funds and ETFs? Here’s a four point checklist from Morningstar

By: | Updated: May 22, 2018 1:48 PM

As there are a lot of options to choose from even in the case of passive funds, we take a look at a four point check-list from Morningstar.

Looking to invest in index funds and ETFs? Here’s a four point check list from MorningstarSensex and Nifty may continue to remain volatile through the year

Even as the Indian stock markets face various headwinds with globally rising crude oil prices and the run-up to assembly elections in 2019, analysts and experts alike say that Sensex and Nifty may continue to remain volatile through the year, and suggest investors to invest through the mutual fund route. In the Indian mutual fund industry, investors can choose to invest in passive funds too, which tracks the returns of a particular index, and also has lower expense ratio. However, since there are various options, with more than 25 index funds currently, it may become difficult for the investors to choose the right fund. In its latest report, Morningstar has come out with a five point checklist to help you choose the right fund.

Dangers in illiquid asset classes

Morningstar notes that in case of illiquid asset ,passive investing can increase the risk of getting caught in a liquidity crisis. “This is a large reason behind the reluctance of Blackrock, Vanguard or State Street to open funds in illiquid assets such as high yield fixed income,” the research firm noted in its report.

Fund size

Fund size is an important consideration for deciding to invest into index-funds. “The number of fund options continue to expand at a rapid rate, which should be viewed with caution for the newest and smallest offering,” Morningstar advises adding that in case of new funds, there can be problems in replicating the index without incurring excessive transaction costs. “This can increase tracking error and lead to underperformance,” says the report.

Check the index that the fund is tracking

It’s imperative to check the underlying index that the funds aim to replicate. As of December-17, there are about 23 index funds in India, and twenty of them tracked the Nifty or the Sensex. Apart from these, there are a a few index funds that track the Nifty Next 50 Index or the Mid-cap index, though the corpus managed by these funds is negligible.

Fees matter

While fees are low in case of passive funds, it’s important to take it into consideration. “Fees still matter. The fee range is still wide, even within the passive universe, so investing blindly into a passive ETF or index fund can result in inferior results,” Morningstar said. The report observes that costs vary depending on the asset class and provider, which will have a significant impact on the net result for the fund. “The process by which they replicate an index will also have an influence on performance, as most providers attempt to add value by actively trading exposures in a risk-controlled manner,” Morningstar said.

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