• Passive investing is an investing strategy that tracks a market-weighted index. It broadly refers to a buy-and-hold portfolio strategy for long-term investment horizons, with minimal trading in the market.
  • Investing in Index funds and ETFs are the most common form of passive investing.
  • An index fund is a type of mutual fund which constructs its portfolio by tracking the composition of a standard market index such as the Nifty 50 or the Sensex. The fund not only invests in stocks which constitute the benchmark index but also the same proportion.
  • For example – a rise of 1% in the index will lead to a 1% increase in the fund and vice versa. There are numerous indexes (Nifty50, Nifty 500, Nifty Smallcap 150) and many others.
  • An index fund is a diversified equity fund delivers returns in line with the index it tracks. For example – a midcap 150 index fund will track the nifty midcap 150 index.
  • The fund manager simply replicates the portfolio of the index in quantity, stocks and proportion. The fund manager has no discretion over stock selection/ strategy of the mutual fund and so the fund has no fund manager bias.
    Index funds are suited for passive investors i.e. investors who are looking to build long-term wealth but.
  • Don’t have time to manage their portfolio
  • Want to stay away from constant monitoring and juggling their mutual fund portfolio.
  • Are skeptical about active fund manager’s long-term efficiency to generate returns above the benchmark index.
  • For an investment horizon of 10+ years – index funds remain the most efficient mutual fund.
  • Just like actively managed mutual funds, index funds are also managed by fund managers. But fund managers have a little role to play as all they have to do is replicate the index.
  • Popularity of index funds is mainly due to following reasons:
  • Index funds are cheap to invest. Fees play a big role in long-term investing
  • Index funds do better than most actively managed funds (especially in the long-term)
  • Survivorship of active funds is low (on an average only 40% of active funds survive after 10 years in the US)
  • Index funds are built to replicate the index and most active fund managers charge fees to outperform indexes. Therefore, an investor who is purely looking to do better than the index should not invest in index funds. It’s important to point out that very few funds end up doing better than the index in the long-run.
  • Low Cost: Since index funds are passively managed, the total expense ratio (TER) is very less as compared to the actively managed ones. While an actively managed fund may charge you anything between 1.5-2.5% as TER, an index fund would typically charge you around 1% (Regular Plan). At face value, the cost difference may seem small but in the long run, it can become as large as 15% of net returns.
  • Diversification: The biggest benefit of mutual funds is diversification. Holding a basket of stocks is proved to be a lot safer than holding individual securities. An index fund has proved to be more diversified since it does not invest in any particular sector, theme or a strategy.Hence lower risk.
  • Minimal Scope for bias: Since the allocation of assets in case of index funds is not at the discretion of the fund manager, there is no scope of making losses due to inefficiency in asset allocation or poor management.
  • Choices: Some index funds track broad market indexes (like large-cap, mid-cap etc.).Meanwhile, others track specific sectors or industry groups thus, offering a wide range of choices.
  • Tax efficiency: There is little to no churn in investing in an index. Therefore – tax is minimized
  • Returns: The average mutual fund typically fails to beat the broad indexes. With this in mind,index funds are a great way to capture broader-market returns.
  • Better Risk Management: Index funds enable easier risk management due to the stability of its portfolio and the weights. In addition, it’s clear that a large cap index is less risky/volatile than a small-cap. It may not be clear for other non-index funds.
  • Long-term investing: Fund managers change, most active funds underperform and funds close down all the time. Index funds negate all of the above. Therefore, great for investing for 10 years+.
  • In order to compensate the managers for their time and expertise for selecting stocks and managing the portfolio, a management fee is charged by active fund managers. Also because of frequent buying and selling of stocks, it leads to increase in trading cost.
  • Index funds which is passively managed, follows a buy and hold portfolio strategy. Constituents of the portfolio seldom change, so fund manager’s role is minimized. That’s why index funds are cheaper than actively traded funds.
    Index funds are passive mutual funds that track a particular index. There are different types of indices in India-
  • Benchmark indices – BSE Sensex and NSE Nifty
  • Sectoral indices like BSE Bankex and Nifty Bank
  • Market capitalization-based indices like the BSE Smallcap and Nifty Midcap
  • Broad-market indices like BSE 100 and Nifty 500
  • All index funds are not same because different index funds track different indices. But the philosophy behind investing remains the same.

  • Like in all mutual funds – there is always risk of losing money in the short-run. An index losing 1% daily will lead to the index fund’s value falling by 1%. However – over the long-run index funds have delivered healthy returns.
Features Exchange Traded Fund (ETFs) Index Fund
Net Assets Value (NAV) Real Time End of the day
Liquidity Provider@ Authorised Participants (APs) on stock exchange + Fund itself Only by Fund
Portfolio Disclosure Daily Monthly
Intraday Trading Possible if investor has required inventory of units Not Possible
Cost effectiveness Each investor bears their own transaction cost Transaction costs are spread across the fund
Holding format Compulsory in Demat form Physical + Demat
Investment decision Can be bought / sold anytime during market hours at prices that are expected to be close to actual NAV of the Scheme. Thus, investor invests at real-time prices as opposed to end of day prices. Not applicable

@ In case of ETFs, the Scheme offers units for subscription/ redemption directly with the Mutual Fund subject to minimum lot size of units which are generally high amounts. Investor can buy/ sell ETF any units in cash segment on secondary market of exchanges where it is listed in multiple of 1unit.

  • All 4 Index funds are very unique and differ in risk and return category. Our goal is to not go sell these funds individually but to allow investors to choose the ones that match their risk appetite and return expectations.
  • For example – a risk lover with high return expectations would choose the Motilal Oswal Nifty Small cap 250 Index Fund/ Motilal Oswal Nifty Midcap 150 Index Fund whereas a risk averse investor may choose the Motilal Oswal Nifty 500Fund.

    Motilal Oswal offers 4 index funds - Motilal Oswal Nifty Midcap 150 Index Fund, Motilal Oswal Nifty Smallcap 250 Index Fund, Motilal Oswal Nifty 500 Fund and Motilal Oswal Nifty Bank Index Fund. While deciding where to invest, you must keep following things in mind-

  • Your risk appetite: How much risk you are willing to take. High returns always come with high risk
  • Your return expectations: All our funds are unique and are built to deliver different risk and return combinations.

    Motilal Oswal AMC has been a pioneer in the ETF space. MOAMC launched their first ETF in 2010 and subsequently launched the other two ETF’s. MOAMC is launching Index funds since they are considered efficient and customer centric. Some other benefits over ETFs are:

  • No Liquidity problems: The industry is plagued with liquidity issues when it comes to trading ETF’s.
  • ETF’s today are mostly bought and sold by institutions who prefer to go directly to the AMC and not the exchange.
  • Retail + HNI customers as a result pay a premium to buy an ETF and sell ETFs at a discount. This adds cost and leads to a higher tracking error for the investor.
  • Index funds however are directly bought from the AMC who provide daily liquidity.
  • Demat Account: All investors wanting to buy an ETF need to open a Demat account and buy the unit on the exchange. Buying an index fund is similar to buying any mutual fund.
  • Brokerage costs: Investors in ETF’s pay brokerage costs (on buying and selling) in addition to the expense ratio. Brokerage and other trading related costs are embedded in the expense ratio
  • Simpler to understandIndex funds are pure passive funds. ETFs however may not be (eg. CPSE ETF). Customers see index funds as natural investment vehicles whereas ETF’s are seen as trading instruments.
  • SIP option Setting SIPs are possible in index funds (not possible in ETF’s).
  • MO index funds are open ended funds, whereby investors have the choice to exit the investment plan anytime. However – we at Motilal Oswal believe index funds are great for long-term investing and therefore want to attract investors who want to buy them from a long-term perspective.
  • In addition – trading (buying and selling securities) incurs transaction costs which are shared by all investors. We want to limit trading and hence have an exit load (up to 3 months).
  • The extent to which the index fund does not track the index properly is known as tracking error. It is the difference between a fund’s portfolio returns and the benchmark index it was designed to track. Low tracking error means a portfolio is closely following its benchmark.
  • Reasons for occurrence of tracking error-

  • Index is a dynamic combination and the constituents change. Till the time the fund manager also adjusts the fund holdings accordingly, there will be tracking error present in the fund.
  • Expense ratio of the fund also drags down the overall performance.
  • Diversification is the process of spreading risk by investing in multiple securities as opposed to a few. The rationale behind diversification is that a portfolio constructed of different kinds of securities will lead to higher long-term returns and lower the risk of buying one or two securities.
  • Benefits of diversification:

  • Minimizing risk of loss:if one investment performs poorly over a certain period, other investments may perform better over that same period, reducing the potential losses of your investment portfolio from concentrating all your capital under one type of investment.
  • Preserving capitalnot all investors are in the accumulation phase of life; some who are close to retirement have goals oriented towards preservation of capital, and diversification can help protect your savings.
  • Generating returnssometimes investments don’t always perform as expected, by diversifying you’re not merely relying upon one source for income.

    Alpha and beta are two of the most important concepts in investing in mutual funds.

    Beta represents market returns or benchmark returns. This index funds are built to deliver beta (market) returns.

    Alpha represents the return in excess of beta returns. For example if the market/benchmark delivers 8% whereas a fund manager delivers 10%, alpha is 2%.

    Every fund manager’s goal is to provide alpha. If he/she fails to deliver alpha, then investors are better off investing in beta products (index funds).

    Ratings from independent sources is one of the convenient ways to compare different mutual funds. But they rely heavily on 3-5 past performance which is not a good indicator of future performance. In addition – independent ratings do not take into consideration risk profile of individual investors.

Expense ratio is defined as per unit cost spent for managing funds. Expenses generally include management fees and operating expenses. Index funds generally have lower expense ratios than actively managed funds.

  • Entry Load:iThis is a charge or commission given by the investor at the time of the initial stage of investment purchase to the mutual fund company. The entry load is usually deducted from the investment amount, reducing the quantum of investment. In India, entry load is zero.
  • Exit Load:Exit load in a mutual fund is a charge paid by the investors for selling mutual fund shares before the fixed time period. The commission is a percentage of the share’s value that is being sold. The return earned on selling the investment is reduced as the exit load is charged from the NAV. Exit load is different for different schemes.

    All mutual fund schemes offer two plans- Direct and Regular. In a Direct Plan, an investor has to invest directly with the AMC, with no distributor to facilitate the transaction and no investment advice.

    In a Regular Plan, the investor invests through an intermediary such as distributor, broker or banker who does all the market research, gives investment advice and is paid a distribution fee by the AMC, which is charged to the plan.

    Therefore, the direct plan has a lower expense ratio as there is no distribution fee involved, while the regular plan has a slightly higher expense ratio to account for the commission paid to a distributor to facilitate the transaction.