One of the biggest advantages of index funds and ETFs is their low cost, points out Sarbajeet K Sen.
ICICI Prudential Mutual Fund recently launched the fund-of-fund (FoF) for its S&P BSE 500 Exchange Traded Fund (ETF).
Another fund based on a broad market index that is already available is Motilal Oswal Nifty 500 Fund, an index fund.
Such products allow investors to get exposure to the bulk of the market through a single fund.
An FoF makes an index-based product available to more customers.
"We launched the FoF with the underlying index as S&P BSE 500 ETF to make the product available to even those investors who don't have a demat account," says Chintan Haria, head-product development and strategy, ICICI Prudential Asset Management Company.
The Nifty 500 index captures more than 90 per cent of India's market capitalisation.
"Passive funds tracking a broad-market index like the Nifty 500 or the S&P BSE 500 greatly simplify diversification within domestic equities for investors. Instead of having to research and buy from a bouquet of large-cap, midcap, and small-cap active funds, buying the entire market (a Nifty 500 index fund) is a simple and effective solution for investors," says Mahavir Kaswa, vice president-research (passive funds), Motilal Oswal AMC.
Lower portfolio risk
Such broad-based indexes offer investors exposure to a variety of defensive and cyclical sectors.
Since this is a market cap-based index, large-cap stocks have higher weight while mid and small-cap stocks have limited weight.
"In case of a meltdown in the broader markets, as happened in 2018, the downside protection is much better, given the presence of large-cap names which tend to be more resilient. In effect, investing in an index like the S&P BSE 500 will help lower portfolio risk to an extent while generating returns that are largely in line with the market," says Haria.
At the same time, the presence of mid and small-cap stocks in the index can provide a kicker to returns.
"These indices also provide exposure to midcap and small-cap stocks, which have historically witnessed higher returns in bull markets," says Kaswa.
These funds tend to outperform funds based on the Nifty50 or the Sensex whenever there is a broad-based rally in the markets (see table).
One of the biggest advantages of index funds and ETFs is their low cost.
"Since these funds are passively managed, the fund management fee is kept at a minimal level," says Harshad Chetanwala, co-founder, MyWealthGrowth.com.
Passive funds also have lower portfolio churn and hence incur lower brokerage costs.
Motilal Oswal Nifty 500 fund, direct option, has an expense ratio of 0.39 per cent while the regular option costs 1.04 per cent.
The ICICI Pru S&P BSE 500 ETF has an expense ratio of 0.28 per cent.
Watch out for tracking error
Keep an eye on the tracking error of these funds.
"These broader indexes will be more difficult to track than an index like the Nifty50 or the Sensex. The latter track large-cap stocks which are highly liquid and hence are easier to track," says Deepesh Raghaw, founder, PersonalFinancePlan, a Securities and Exchange Board of India-registered investment advisor.
Should you invest?
These funds based on broad-market indices are a good solution for investors who don't have access to quality research or advice.
"An investor who doesn't want to manage investments across market caps, and who wants exposure to a broad set of companies, may look at these funds," says Chetanwala.
They can be a good option for those who have entered equity markets for the first time, or those who want to take less risk.
Investors who have medium to high risk appetite and would like to build their own portfolios using funds based on different market caps may avoid them.
Such investors will have the flexibility to alter exposure to large-cap versus mid and small-cap segments, depending on valuations and outlook.
Experts say investments into these funds should be done via the systematic investment plan (SIP) route.
Feature Presentation: Aslam Hunani/Rediff.com