beware of the Index huggers

investing is a tedious process. we all know that money can be made in the stock market but don’t know which stocks will turn out to be multibaggers and which will go bust.

one solution to this problem is to pay a fee to an expert who will invest on your behalf in a portfolio of companies. that’s how mutual fund schemes work.

mutual fund schemes are either actively managed by a fund manager, the expert you pay the fee for generating market-beating returns, or they are ‘passively’ managed where the scheme would follow the composition of an existing market index such as the Nifty50 or Sensex.

the indices also serve as a benchmark for various schemes. an actively managed large-cap scheme would have the Nifty50 or Sensex as a benchmark against which the performance of the scheme is measured.

now imagine if the expert you are paying a fee to manage and grow your wealth does that without putting any effort or by copying the homework of another or just by ripping off a strategy from YouTube. would you be happy? probably not.

but here’s the thing, this happens a lot with mutual funds.

what is an index hugger

this is what an index hugger does. an index hugger is a term used for active fund managers who sneakily track and manage their funds in line with the composition of their benchmark index.

so even though these fund schemes are marketed as ‘active’, they in fact require limited management since the returns follow the index that they are benchmarked to. the index huggers are actively managed mutual funds schemes that resemble an index like the Nifty50. 

in effect, an investor pays more since it is an ‘active’ fund and ends up getting offered a scheme simply tracking another index. passive funds that don’t need active management of the portfolio come at a lower cost.

things to remember while investing

while investing in a mutual fund scheme, investors should pay attention to the portfolio of the fund and how it tallies with the composition of its benchmark. if you find that there’s a major overlap then it’s best to stay away from a scheme that is overcharging you while copying someone else’s work.

in short, index hugger schemes are an overpriced version of an index, the benefits of which can be obtained either by an index fund or exchange-traded fund (ETF) at a fraction of the cost.