Looking for large and mid-cap equity exposure? Consider Index Funds

The objective of a passively-managed index fund is to generate returns by repeating the index module, if any, by purchasing the constituent stocks in the same proportion as the index, allocating the same amount.

Investing in stocks is an acceptable proposition for wealth creation in the long run. Mutual funds are a preferred option for this. But due to the plethora of mutual fund schemes, it becomes difficult for many investors to make an investment choice. Especially for those who do not have consultants or distributors.

Most investors are comfortable owning shares in large and medium-sized companies. For them, large-cap equity funds, flexi-cap equity funds and mid-cap equity funds become natural choices. But these options also face some challenges, such as selecting, tracking and reviewing individual plans, and rebalancing between large and midcap allocations in them from time to time. Because of these challenges, investors usually look for easy-to-execute avenues of investment.

The objective of a passively-managed index fund is to generate returns by repeating the index module, if any, by purchasing the constituent stocks in the same proportion as the index, allocating the same amount. This gives investors the right mix of stock exposure.

A fairly diverse index provides exposure to businesses spanning sectors – from financial, IT, consumer to chemical, and healthcare, among others. This approach of allocating equal amounts of money works in favor of the investors. Investors get exposure to both established businesses and growing businesses. Timely rebalancing in these funds allows the stock to book profits in a particular market cap when it is outperforming the other. Since it is an index built on the free-float market capitalization of a stock, it allocates more to winners and minimizes risk for under-performers, which puts it ahead of some other investment styles in the long run.

Diversified indices do not have a specific allocation ratio among the market caps of the stocks. A fund providing exposure to the entire market represents a strategy of collective market intelligence. This strategy usually provides above-average returns compared to peer group funds. Uniform allocation, auto-rebalancing every quarter, have helped these index funds outperform most flexi-cap and large-and-mid-cap funds over three, five and 10 years.

Reviewing and tracking investments in index funds is relatively easy compared to tracking investments in actively managed funds. Such schemes can be viewed as a complement to existing investments in actively managed equity schemes. The savings on account of lower cost also add to the returns in the long run.

A carefully chosen index fund should be a suitable option for first time investors who are willing to start their investment journey as such investors put a lot of effort in choosing schemes and allocating funds among them. Instead, they can start a SIP and get equity asset class exposure with minimal effort. Even investors who do not have access to advisors and distributors and who make their own investment decisions can consider investing in a good index fund for the sake of simplicity in their portfolios.

(Niranjan Awasthi, Head-Product, Marketing & Digital Business, Edelweiss AMC)

Disclaimer: These are personal views of the author. Investors are advised to consult a financial planner before making any investment.