What is an Index Fund - Definition, Types and More

Looking for a broader market exposure at a lower cost and diversifying at the same time? A passively managed fund might be effective for you, and an Index fund might be suitable here. Such funds track specific market benchmarks or indices such as Nifty 50 or Sensex.

By tracking the market indices, such a fund aims to match the return from the market but does not beat it.

Among the more than 5.20 crore mutual fund investors in India, approximately 34% also invest in index funds. If you are curious to know what it is in detail and its types, read through this blog.

A Quick Definition of Index Funds

Index funds, by categorisation, are passively managed mutual funds. It means that, unlike actively managed funds, it does not require an active buying or selling decision. Such funds aim at replicating the performance of their respective market indices.

For example, suppose while looking to invest in a passive fund following the Nifty 50. It means such a fund across all 50 constituents of this index, and with weightage allocated proportionally. Now, by investing, if the overall index rises, the value of the fund increases.

Therefore, such a passive approach reduces the overall management cost of funds. Such costs are typically higher in actively managed funds such as equity or debt-oriented funds. Also, some index funds might not impose a typical exit load in mutual fund, which also reduces your expenses.

It also helps avoid human errors and is usually attractive for investors looking for long-term growth.

Types of Index Funds Available to Invest in India

Although the primary aim is to replicate the market index here, there are multiple types of these funds available. Following is a detailed breakdown of its types so that you can choose one informedly:

1.    Broad Merket Index Funds

As its name implies, such a fund type focuses on the broader or larger segment of the market. For example, there are index funds that track the Nifty 500. This index covers the top 500 companies listed on the NSE.

Also, there are Nifty 100 index funds, and thus, with a larger focus, you get an exposure to a wider range of companies across sectors, lowering dependency on a few stocks.

2.    Market Capitalisation Index funds

Such funds focus on constituents of an index based on their market capitalisation. With such a focus or a strategy, such funds cover segments such as large cap, mid cap and small cap. Thus, such index funds generally have the potential to enable diversification across different market sizes and capitalise on their growth prospects.

3.    Bond Index Funds

While being a risk-averse investor, you might choose a debt-oriented fund, or in passive funds such as the index funds, such an option is available. Bond index funds generally focus on bond market indices. Thus, it provides a conservative investment option for investors who want to avoid the risks of assets such as equities.

4.    Sector-Focused Index Funds

When you are looking to invest in mf through an index fund, you might encounter a sector-focused index fund. Such index mutual funds generally invest in companies that operate in the same industry or sector. For example, there are sectoral index funds available, such as Nifty PSU, Nifty Bank, Nifty Healthcare, Nifty Technology, as their underlying indices. 

Conclusion

An index fund is a passively managed fund that tracks and replicates the performance of market indices such as the Nifty or Sensex. Based on its structure, there are different sorts of index funds available that cover a broader market, capitalisation, types of assets, or sectoral performance.