The mutual fund behemoth, Unit Trust of India launched the first index fund, Master Index Fund in the country in June, 1998 and opened for continuous sale and repurchase in October, 1998. In the past three months till date, the Master Index Fund has appreciated 12.90 per cent while the Sensex, which it replicates, has grown 15.07 per cent. Effectively, the fund has underperformed the index by 2.17 per cent. Master Index Fund is a passively managed index fund replicating the BSE-30 set. The funds mobilised under the scheme will be invested in the equity shares of companies comprising the BSE Sensex in the same proportion as that of the index so as to track the index, with minimum tracking error. There shall be no income distribution under the plan.As index funds essentially replicate the market index, these represent the characteristics and attributes of the chosen target index. Hence, the rate of return on the portfolio is very close to the the rate of return on index. In other words, indexing is astructured portfolio strategy where the benchmark is to achieve the performance of the predetermined index.
Any marginal underperformance or outperformance has to be a tracking error. At times, the fund may not be able to exactly replicate the proportion of the index constituents and if the fund happens to be slightly overweight on scrips that depreciated more than the average, the fund will underperform the index marginally and vice-versa.
In addition, since funds incur management costs and hold some cash to meet redemption requirements, it pulls down the returns. It is here that the role of the fund manager is crucial. He has to use his intellect in earning enough to offset the costs and give the investors a market rate of return.
The underperformance of Master Index Fund is not alarming but it makes the fund unviable for marketmen wanting to take short term bets. Further, the fund also charges an exit load of 3 per cent. A 3 per cent exit load would suggest that the sensex will have to appreciateover 3 per cent to provide a positive return to the investor.
Considering a Sensex level of 3000, the index will have to gain 90 points for the investor to break-even.
The minimum investment under Master Index fund is Rs 5000 and is sold at NAV. In fact, for an average investor, an index fund could turn out to be a boon. For one, it eliminates the risk relating to the choice of shares by investors and the managed growth funds.
After the revamp, the Sensex has become more representative and looks smarter. With this change, Master Index should be able to deliver better. However, index fund is appropriate only if you are satisfied with an average rate of return. If you are expecting above average or extraordinary returns - it is highly unlikely - so forget it. Otherwise you will be in for a big disappointment.
-- Value Research
Copyright © 1999 Indian Express Newspapers (Bombay) Ltd.
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