Index investing is popular in developed markets, but it is still in early stages in India and is yet to gain momentum. However, the recent re-categorisation of mutual fund schemes by the market regulator has contributed to an increase in popularity of index funds. Various options for index investing in India include Nifty, Bank Nifty, index funds and ETFs. Bank Nifty is the India’s second most followed economic indicator after Nifty. ETFs and index funds are, by definition, inexpensive products that track an underlying benchmark closely. The corpus of the index funds is invested in stocks constituting the underlying index in the same proportion as in the index and they endeavour to track the benchmark index.
In the stock market, the index is made up of a representative collection of stocks that are important for the economy. Index stocks are selected on a free float basis and adjustments are made from time to time, keeping in view market conditions, market opportunities, applicable regulations and economic factors. A stock must be available for trading in the futures and options segment to be eligible for inclusion in an index. Besides, market capitalisation, liquidity and trading frequency are other criteria.
Actually, stocks that under perform and in turn see a fall in market capitalisation are replaced by other stocks which perform better and have more market cap than the underperformers. Besides, exclusion may happen in the case of a spinoff, merger or acquisition. There are also no stock-specific risks in investing in index, since the index stocks are of established companies and have proven track records. Individual stocks may rise and fall, but indices tend to rise over time.
Investing in index is a passive strategy, which helps manage risk and gain consistent returns. It exposes investors to a broad selection of stocks, allows diversification and this ultimately minimises risk. As an index fund comprises stocks in similar proportion of the benchmark, hence, it delivers returns more or less in line with the benchmark. Index investing is ideal for investors who are risk-averse and want predictable returns. It does not require extensive tracking as it has low expenses ratio.
Let’s take the example of Nifty BeES. Investing in Nifty BeES offers the benefits of diversification, index tracking and low expenses. As it is listed and traded on NSE, Nifty BeES can be bought or sold just like stocks and can be held in the demat account with other portfolio holdingsNSE -0.44 %. Its performance is simply the result of performance of stocks in the Nifty index and demand and supply in the market. As Nifty BeES replicates Nifty, investors can know at any given point of time how much is invested in each stock.