Groww to Motilal Oswal: Are broad-based index funds worth investing into?

Most of the index funds invest in a large number of securities. These broad market index funds offer greater diversity, signifying that they invest in a large number of securities

In the last month, two fund houses have launched broad-market index funds in order to tap into the growing popularity of passive funds. 

According to Sebi, an Index fund is defined as an open-ended scheme that tracks or replicates the market’s index. The minimum investment in the securities for any particular index that is being tracked or replicated must be 95% of the total assets. The broad market index fund is also a type of mutual fund that contains investments that help track a large index. Such funds invest in a large group of stocks that represent a broader equity market.

The market share of passive funds has jumped from 1.4% of AUM in 2015 to over 17% today. According to a survey by Motilal Oswal, 61% of investors have invested in at least one passive fund while 57% of respondents prefer these funds due to their low-cost nature as the biggest reason, followed by 56% of respondents who feel that the simplicity of these funds is what pulls them to invest in them, and more than 54% investors do so for the fact that they tend to deliver market returns. 

Groww Mutual Fund has launched the Nifty Total Market Index Fund and its new fund offer (NFO) is open till October 17 while Motilal Oswal AMC has launched the Motilal Oswal Nifty 500 ETF, which is expected to list on the NSE on November 6, 2023.

The Grow NFO aims to track the performance of all market-cap segments of the Indian market through a single offering. It encompasses about 750 stocks, spanning the large, mid, small, and microcap segments and is the first Nifty total market index fund in India.

Motilal Oswal on the other hand wants to replicate the total returns of the Nifty 500 Index, which is designed to measure the performance of the top 500 companies based on market cap.  Nifty500 index is a broad-based index of the top 500 companies in India. These companies represent 96% value of the free float market. 

The SBI Nifty 50 ETF and the SBI S&P BSE Sensex ETF have also gained popularity and accumulated impressive assets under management. Among other existing schemes, the Motilal Oswal Nifty 500 Index Fund, launched in 2019, had an AUM of Rs 525 crore as of August-end. ICICI Prudential S&P BSE 500 ETF, launched in 2018, has assets of 117 crore, while the HDFC S&P BSE 500 Index Fund, launched in 2023, has assets of Rs 15 crore.

 

"Compared to the Nifty 50 Index, the Nifty 500 Index is well-diversified, with its top 10 holdings accounting for only 37%, as opposed to 58% in the Nifty 50 Index. Furthermore, it provides diversified exposure to 21 sectors, some of the sectors include textiles, consumer services, media, and forest materials that are not present in the Nifty 50 Index. The index offers an excellent blend of Largecap (75%), Midcap (16%) and Smallcap (9%)," according to Motilal Oswal Management Company.   

Note: The Nifty 500 index includes approximately 96 per cent of the free float market capitalisation, divided into large-cap (1-100 stocks based on market cap), mid-cap (101-250 stocks), and small-cap (250-500 stocks).

The Nifty Microcap 250 index consists of the top 250 companies beyond the NSE 500, ranking from the 501st to the 750th-largest companies in the country. There is no official SEBI categorisation for the micro-cap segment.

According to Value Research, Groww's total market index fund is designed to hold only 3.44 per cent of stocks, which is different from the Nifty 500 index. Both Nifty 500 and Nifty Total Market Index are market-cap-based indices, and their constituents may change during half-yearly reviews. Even the difference in returns between the total market index and the Nifty 500 is not significant; their returns almost overlap.

When compared to the Nifty50,  the Nifty Total Market Index delivered returns of 11.37 percent  as opposed to 9.53 percent for the Nifty 50. On a five-year basis, the Nifty Total Market Index’s returns were 12.54 per cent compared with 11.84 per cent delivered by the Nifty 50.

"The additional 250 stocks offered by the Nifty Total Market index have a weightage of little over 3 per cent. This is too little to make any meaningful difference over and above what one would get by investing in the Nifty 500 index.

That being said, individuals seeking a fund that tracks a more extensive index may consider the Nifty 500, for which several schemes are already available in the market," said Karan Jaiswal of Value Research.

Should you opt for such funds?

Shruti Jain, CSO, of Arihant Capital, believes that the Groww Nifty Total Market Index Fund is ideal for investors seeking exposure to a broad market rally and that it caters to those aiming for sustained returns and extensive diversification.

Nirav Karkera of Fisdom believes with such funds an investor can participate in the market without the risk of active fund management, so it is suitable for first-time investors.

But from a diversification viewpoint, both these funds may be an overkill. 

"An index is constructed based on the free float market cap of the underlying companies. So, the higher the free-float market cap of the company, the more weight it gets on an index. Within the Nifty-50 Index, the top 10 stocks comprise approximately 60% of the weight, and the rest 40% goes to 40 stocks. These same stocks are also present in the Nifty-500 (and again, for a significant chunk of it). Beyond these 50 stocks, a Nifty-500 investor invests in 450 other stocks, which do not have much significance in the Nifty-500 index. Therefore, the Nifty-500 index does not solve much from a diversification standpoint. On the other hand, it increases the risk because the investor is almost like buying the whole market," explained  Ajinkya Kulkarni, Co-Founder and CEO, Wint Wealth.

Similarly, Groww Nifty Total Market Index Fund aims to mirror the returns of the Nifty Total Market Index fund, which comprises 750 stocks. Such extensive diversification is like buying the entire market without any filters. The portfolio will always have a massive chance of holding too many poor-quality or overvalued stocks for too long. 

"For retail investors, investing in a combination of Nifty 50 and Nifty Next 50 indexes, based on their risk appetite, can be more rewarding," said a certified financial planner, on condition of anonymity. 

Another big drawback of index funds is  the absence of fund manager discretion. For example, if the equity fund manager finds the market to be too volatile, then the cash allocation can be increased substantially. However, an index fund does not have that flexibility as it has to be fully invested in the index at all points in time.

To illustrate, consider that out of 24 active large-cap funds, an impressive 20 have outperformed the S&P BSE 100 Total Returns Index (TRI) on a 10-year rolling basis, since 2010," said Ravi Banagere of Value Research.

Banegra believes it may still be prudent for investors to allocate a small part of their assets to index funds in their portfolio.

"Having 1-2 index funds with exposure to the broad equity market can provide long-term benefits. That said, don't allocate more than 10 per cent of your money to these funds."