Q. I am a 32-year-old doctor working with a multispeciality hospital in Noida, Uttar Pradesh. I have been investing in Nifty 50 tracking mutual funds for a long time on advice of my father. However, I do not understand how index mutual funds work, specifically I want to understand what are the differences between index mutual funds tracking Sensex and Nifty 50.
If you are looking for a passive way to invest in the Indian stock market, you might have come across index mutual funds. These are funds that aim to replicate the performance of a specific market index, such as the S&P BSE Sensex or the NIFTY 50.
What are Sensex and Nifty?
The S&P BSE Sensex, or simply Sensex, is the oldest and most widely followed index in India. It consists of 30 large-cap companies from various sectors, representing about 45% of the total market capitalization of the BSE (Bombay Stock Exchange). The Sensex is calculated using the free-float market capitalization method, which means that only the shares available for public trading are considered.
The NIFTY 50, or simply Nifty, is another popular index in India. It consists of 50 large-cap companies from 13 sectors, representing about 65% of the total market capitalization of the NSE (National Stock Exchange). The Nifty is also calculated using the free-float market capitalization method.
Both indices are considered as benchmarks for the Indian equity market and are used by investors, analysts, fund managers, and regulators to measure and compare the performance of various stocks, funds, and portfolios.
What are index mutual funds?
Index mutual funds are a type of mutual fund that invests in a basket of stocks that mimic the composition and weightage of a specific index. The objective of these funds is to provide returns that are similar to or match the returns of the underlying index, minus the fees and expenses. Index mutual funds are also known as passive funds, as they do not involve active stock selection or portfolio rebalancing by the fund manager.
Index mutual funds offer several benefits to investors, such as:
Low cost: Index mutual funds typically have lower expense ratios than actively managed funds, as they do not incur high research, trading, or management costs.
Diversification: Index mutual funds provide exposure to a broad range of stocks across different sectors and industries, reducing the risk of concentration and volatility.
Transparency: Index mutual funds disclose their portfolio holdings on a daily basis, allowing investors to know exactly what they are investing in and how their fund is performing.
Tax efficiency: Long term capital gains tax on Index mutual funds tracking Nifty 50 and Sensex is 10% which is low when compared to long term capital gains tax on other asset classes such as gold.
Differences between index mutual funds tracking Sensex and Nifty
While both Sensex and Nifty are broad-based indices that reflect the overall performance of the Indian equity market, there are some differences between them that can affect the returns and risk profiles of the index mutual funds that track them. Some of these differences are:
Number of stocks: The Sensex has 30 stocks, while the Nifty has 50 stocks. This means that the Nifty has more diversification and lower concentration risk than the Sensex. However, it also means that the Nifty has more stocks to track and replicate, which can increase the tracking error and operational costs of the index mutual funds.
Sector allocation: The Sensex and Nifty have different sector allocations, depending on the weightage and performance of their constituent stocks. For example, as of September 2023, the Sensex had a higher allocation to financial services (40.6%), consumer goods (12.9%), and energy (11.8%), while the Nifty had a higher allocation to information technology (18.1%), automobile (10.4%), and pharmaceuticals (6.9%). These sector differences can affect the returns and volatility of the index mutual funds, depending on the sectoral trends and cycles in the market.
How to choose between index mutual funds tracking Sensex and Nifty?
There is no definitive answer to which index mutual fund is better than the other, as it depends on various factors such as your investment objective, risk appetite, time horizon, cost preference, and performance expectation. However, here are some general guidelines that can help you make an informed decision:
- If you are looking for a simple and low-cost way to invest in the large cap companies, you can choose any index mutual fund that tracks either the Sensex or the Nifty, as both indices are well-diversified and representative of the market.
- If you are looking for more diversification and exposure to different sectors and industries, you can choose an index mutual fund that tracks the Nifty, as it has more stocks and sectors than the Sensex.
- If you are looking for more liquidity, you can choose an index mutual fund that tracks the Sensex, as it has larger and more established companies than the Nifty.
- If you are looking for lower tracking error and operational costs, you can choose an index mutual fund that tracks the Sensex, as it has fewer stocks to track and replicate than the Nifty. However, you should also compare the expense ratios and tracking differences of different index mutual funds before investing.
Index mutual funds tracking Sensex and Nifty are both popular and convenient ways to invest in the Indian equity market. However, they have some differences in terms of their composition, sector allocation, market capitalization, returns, and risk profiles. Therefore, investors should understand these differences and choose the index mutual fund that suits their investment objective, risk appetite, time horizon, cost preference, and performance expectation.
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Note: This is for informational purposes. Please speak to a financial advisor for detailed solutions to your questions.