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Index Funds In India: Everything You Should be Aware Of

Different investing styles

Fund managers follow two different styles of investing, based on which they offer two types of mutual fund schemes to their investors. They offer active funds, wherein the fund manager plays an active role in-stock selection, quantity to buy, when and at what price. The same applies to selling a stock. Fund houses also offer index funds in India, wherein the fund manager doesn’t have a say in any of the above things. This article will talk about index funds in India and everything you should know about them.

What is an index fund?

As per SEBI regulations, an index fund has to invest 95% of its total assets in the securities of a particular index it is replicating or tracking. An index fund invests its money in all the index constituents in proportion to their weightage in the index.

For example, a Nifty 50 index fund will invest a minimum of 95% of its total assets in the Nifty 50 Index. It will invest in all the constituents of the Nifty 50 Index in proportion to their weightage in the index. The National Stock Exchange (NSE) offers various indices. Fund houses offer index funds or ETFs based on these indices.

Some of the indices offered by NSE and the index funds or ETFs based on them include:

Category Index Index Fund or ETF
Broad market indices Nifty 50 ICICI Prudential Nifty Index Fund
  Nifty Next 50 SBI Nifty Next 50 Index Fund
  Nifty 100 Axis Nifty 100 Index Fund
  Nifty Midcap 150 Nippon India Nifty Midcap 150 Index Fund
  Nifty Smallcap 250 Motilal Oswal Nifty Smallcap 250 Index Fund
Strategy indices Nifty50 Value 20 Index Nippon India Nifty 50 Value 20 Index Fund
  Nifty50 Equal Weight Aditya Birla Sun Life Nifty 50 Equal Weight Index Fund
  Nifty100 Equal Weight Index Sundaram Nifty 100 Equal Weight Fund
  Nifty200 Momentum 30 Index UTI Nifty200 Momentum 30 Index Fund
  Nifty 100 Quality 30 Index Edelweiss Nifty 100 Quality 30 Index Fund

 

The table above shows the various index funds and ETFs offered by mutual fund houses based on broad market indices and strategy indices. Similarly, fund houses also offer index funds in India on various sectoral and thematic indices. These are a great vehicle for investors to build their index funds India investment portfolio.

How to select an index fund for investment?

Now that we know about the various index funds in India offered by fund houses, let us understand how to select an index fund for investment. While selecting an index fund, you should consider the following parameters:

1. Expense ratio

A fund house has to incur various expenses to run a scheme. Some of these expenses include commission paid to mutual fund distributors, scheme advertising and marketing expenses, staff salaries, administration expenses, brokerage, Government levies, etc. All these expenses are charged to the index fund as a percentage of the scheme assets. The percentage charged is known as the expense ratio. While selecting an index fund for investment, you should compare the expense ratio of similar schemes. The lower the expense ratio, the better.

2. Tracking error

The fund manager invests most of the scheme money in the index constituents. However, they maintain some cash levels to meet the scheme redemption requirements and expenses. Due to the cash levels, the scheme returns are slightly lower than the benchmark index returns. The tracking error is the difference in returns between the benchmark index and the scheme. While selecting an index fund for investment, you should compare the tracking error of similar schemes. The lower the tracking error, the better.

An ideal combination of an index fund for investment will be the lowest expense ratio and lowest tracking error.

3. Assets under management

While comparing index funds within the same category, you should consider a fund with higher assets under management (AUM). While AUM is an important parameter, it should not get more consideration than expense ratio and tracking error. The higher the scheme AUM, the better.

Taxation of index funds in India

The taxation of an index fund depends on whether it is classified as an equity fund or a debt fund. If the equity component of an index fund is always higher than 65%, then it is classified as an equity fund and taxed accordingly. Any fund that is not an equity fund will be taxed like a debt fund.

Taxation of equity index funds in India: If you sell your equity index mutual fund units before 12 months, the capital gain will be classified as short-term capital gain (STCG). The STCG will be taxed at 15%. If you sell your equity index mutual fund units after 12 months, the capital gain will be classified as long-term capital gain (LTCG). The LTCG of up to Rs. 1 lakh in a year will be exempt. The incremental LTCG above Rs. 1 lakh in a year will be taxed at 10% without indexation benefit.

Taxation of debt index funds in India: If you sell your debt index mutual fund units before 36 months, the capital gain will be classified as short-term capital gain (STCG). The STCG will be added to your overall income and taxed based on your income slab. If you sell your debt index mutual fund units after 36 months, the capital gain will be classified as long-term capital gain (LTCG). The LTCG will be taxed at 20% with indexation benefit or 10% without indexation benefit.

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