Mutual Funds: Why Investors Should Consider Broad-Market Index Funds?

The robust growth of the Indian economy is directly linked to the performance of its stock markets. As sectors like services and agriculture grow, they boost investor confidence, leading to increased market participation and higher valuations. This positive sentiment in the stock markets in turn encourages further investment in these growth sectors, creating a virtuous cycle of economic and stock market growth.

Over the last decade, Indian stock markets have witnessed impressive growth. The BSE Sensex, which was around 25,000 in 2014, has tripled to reach around 75,000 by 2024. Similarly, the Nifty 500 has more than doubled in the last five years. Despite periods of volatility, the resilience and growth trajectory of the Indian stock market has been remarkable.

India has a diverse investment landscape, from established financial giants to innovative startups. But navigating the vastness can be challenging. Here’s how investing in broader market index funds can empower you:

Diversification is important to reduce risk

Imagine putting all your eggs in one basket. If that basket falls, so will your investment. Diversification is the antidote to this risk. It involves spreading your investments across different asset classes, sectors and company sizes. This approach mitigates the impact of a company or sector in crisis. Therefore, when investors are exposed to a broader index that captures the entire Indian economy, they are primed to benefit.

Broad index funds achieve this by holding a basket of companies from different industries and market capitalizations. This inherent diversification eliminates the need to actively select individual stocks, thereby reducing the risk associated with the performance of a single company.

Exposure to growth potential and market dynamism

Beyond established large caps, broader equity indices encompass promising mid and small cap companies. These represent the future of the Indian economy, brimming with innovation and high growth potential. By investing in a broad market index fund, investors can gain automatic exposure to this untapped potential alongside established giants. Moreover, by spreading investments across sectors, investors tend to become less vulnerable to downturns in a particular sector.

Markets are inherently dynamic, with sectors and companies taking turns to lead the charge for growth. Broad market index funds, by design, constantly adjust to reflect this dynamism. They automatically rebalance as companies’ market capitalizations change, ensuring that the portfolio remains in sync with the changing market landscape.

Understanding risk as a spectrum, not a binary

Rather than a binary win-lose scenario with individual stocks, broader market funds expose investors to a range of opportunities. The inherent diversification across sectors and market capitalizations means that poor performance in one area can be offset by strong gains in another.

allows investors to observe the historical spectrum of market risks and rewards, providing valuable context for their own investment decisions.

In fact, it would not be an exaggeration to say that the very nature of a broad stock index is that it inherently balances risk and return. This helps assess the overall risk/return profile of the market.

A simplified approach for the long term

To conclude, investors should understand that market index funds are passively managed, mirroring the constituents of a chosen index. This allows investors to passively learn from the collective wisdom of the market. Over time, the composition of the index reflects the sectors and companies that are driving India’s growth, providing a real-world education on the dynamics of risk and reward within the Indian market.

Investing in a broader market index fund therefore offers a simplified approach to capturing India’s long-term growth. Investors can gain exposure to a diversified basket of companies, benefit from automatic rebalancing and enjoy a cost-effective strategy, while minimising the need for constant market monitoring and stock selection.

Source: Internal research NSE, BSE, Axis MF as of June 20, 2024

Note: The sectors mentioned above are used to explain the concept and are provided for illustration purposes only and should not be used for the development or implementation of any investment strategy. They should not be construed as investment advice to any party. Past performance may or may not be maintained in the future.

Vikash Wadekar, Head of Liabilities, Axis Mutual Fund