Index Fund Corner
Sponsored
| Scheme Name | 1-Year Return | Invest Now | Fund Category | Expense Ratio |
|---|---|---|---|---|
| Axis Nifty 50 Index Fund | +32.80% | Invest Now | Equity: Large Cap | 0.12% |
| Axis Nifty 100 Index Fund | +38.59% | Invest Now | Equity: Large Cap | 0.21% |
| Axis Nifty Next 50 Index Fund | +71.83% | Invest Now | Equity: Large Cap | 0.25% |
| Axis Nifty 500 Index Fund | — | Invest Now | Equity: Flexi Cap | 0.10% |
| Axis Nifty Midcap 50 Index Fund | +46.03% | Invest Now | Equity: Mid Cap | 0.28% |
According to Morningstar, assets under management (AUM) in passive products have increased nearly sixfold in the past five years, with the number of passive funds growing from 149 in 2020 to 537 as of December 2024.
This surge is supported by regulatory backing, such as the Employees’ Provident Fund Organization’s (EPFO) investments in ETFs
, and increasing investor awareness.
As passive strategies become mainstream, selecting the right index fund is critical.
Morningstar’s recent report, A Practical Guide to Selecting an Index Fund, outlines key factors investors should consider before choosing an index fund.
Choose the right asset class first
The most fundamental decision in index investing is selecting the appropriate asset class.
“Markets with high volatility, liquidity constraints, and inefficiencies often favor active management,” said Kongkon Gogoi, Senior Analyst, Manager Research at Morningstar.
On the other hand, highly efficient markets with rapid price discovery are well-suited for passive investing.
Investors should align their choices with their financial goals. Whether seeking broad market exposure through large-cap equities, targeted exposure to a specific theme, or specialised investments like factor-based strategies (low volatility, momentum, or value), the right asset class selection is the foundation of a strong portfolio.
Consider investability
Not all indexes are equally investable. Some benchmarks include illiquid securities, making them harder to track.
“Indexes with high trading costs can erode returns,” Gogoi noted. For example, small-cap stocks, high-yield bonds, and less-traded fixed-income securities tend to have lower liquidity, leading to performance drag.
An index should have ample market depth and liquidity for efficient replication. Investors should also check whether mutual funds or ETFs track the index, as the presence of investable products indicates market confidence in its practicality.
Look for diversification and representativeness
A well-constructed index should capture the full opportunity set of its asset class while avoiding excessive concentration. “Highly specialised or narrowly focused indexes introduce idiosyncratic risks,” Morningstar warns.
While thematic and sector-specific indexes may serve tactical purposes, they do not always align with the core principles of passive investing.
Assess index construction rules
A transparent and well-designed index follows clear rules based on sound economic principles. However, some popular indexes have structural flaws. “
The Nasdaq-100 Index excludes major companies listed on other exchanges, which has no economic basis,” Morningstar notes.
Similarly, the Dow Jones Industrial Average, which consists of only 30 stocks selected subjectively, is weighted by price rather than market capitalisation.
A good index should be rule-based and transparent, ensuring that investors can anticipate its behavior across different market environments.
Check tracking error
The effectiveness of an index fund depends on how closely it replicates the index. Tracking error measures this accuracy. “Investors should prioritize funds with low and stable tracking error to ensure performance closely matches the index,” Gogoi emphasised.
A higher tracking error can indicate inefficiencies in execution or hidden costs.
Market makers matter for ETFs
For ETF investors, market makers play a crucial role in ensuring liquidity and fair pricing.
“Market makers keep bid-ask spreads tight and help ETFs trade close to their net asset values (NAVs),” Morningstar explains.
When markets become volatile, ETFs with fewer market makers can experience price deviations, leading to liquidity issues.
Recognizing this, the Securities and Exchange Board of India (SEBI) introduced a regulatory framework in May 2022, requiring asset management companies to appoint at least two market makers for each ETF.
This ensures stability and protects investors from inefficiencies.
