Index funds offer investment based on market capitalisation. The strategy of these funds is not to actively manage the portfolio and mimic the indices created by NSE or BSE based on market capitalisation.
By Harshad Chetanwala
Index funds and international funds have drawn the attention of investors in the last couple of years. Both these funds help you to invest in well-established and growing companies within India and outside of India. For years, most investors have looked at actively managed funds focusing on Indian equities to create wealth for them. Now, is there a need to change that strategy or create a blend of equity diversified, index and international fund?
Index funds offer investment based on market capitalisation. The strategy of these funds is not to actively manage the portfolio and mimic the indices created by NSE or BSE based on market capitalisation. For example, if today the weight of HDFC in Nifty 50 is 10%, then the index fund will also have 10% of its portfolio in HDFC. The fund will rebalance its portfolio on a regular interval and bring it in line with the weightage of the index. From a cost perspective, the expense ratio for index funds is low compared to other equity diversified funds, as there is no need for active fund management or research. Some well-known index funds are Nifty50 Index Funds, Sensex Index Funds and NIFTY Next 50 Index Funds.
View on index funds
Index funds have the potential to generate good returns for investors, however, the consistency of index funds outperforming active funds over the long term depends on the maturity of the economy and depth in the stock market. In developing countries like India, there exist opportunities for businesses to improve efficiency and perform well across different sectors. There are companies that have potential to grow at a faster rate compared to those with high market capitalisation. Hence having a blend of both active and index funds in your portfolio can work better. The allocation in index funds can be high for first-time or low-risk profile investors. Investors with moderate or high-risk profile may have 15 – 20% allocation in index funds.
International funds help you invest in companies outside of India and diversify your investment across different countries. These funds predominantly invest in a basket of equity funds based on different themes or countries. At present, preferred international funds are those investing in USA, China and globally diversified companies. Through these international funds, you can invest in companies like Alphabet (Google), Apple, Microsoft, Amazon, Facebook, Samsung, Tenent, Alibaba, etc.
View on international funds
Investors with moderate to high-risk profile or those who have built reasonable allocation in India based equities can look at international funds. Such investors may allocate 10% of portfolio in international funds. Investors who have just started their investment in equities or who have low risk appetite may avoid it at this stage.
While both index funds and international funds have done well in the past and do have the merits to be a part of your portfolio, you should add them gradually in your portfolio and continue to diversify across different market capitalisation and sectors to reduce the overall risk and generate good long-term return.
The writer is co-founder, MyWealthGrowth.com