Index investing has gained a lot of popularity in recent times. The assets under management (AUM) of index funds stood at Rs 1.73 lakh crore in FY 22, up 197% compared to the FY21 AUM, which was at Rs 58,173 crore, according to data from the Association of Mutual Funds in India (AMFI).
Index investors have two choices: ETFs and index funds.
But if you want to invest in an index such as NIFTY 50, should you go with NIFTY 50 ETF or NIFTY 50 index fund? Let’s find out if one is better than the other.
But before we begin, it will be better if we first understand the difference between the two instruments.
Difference Between Index Funds And ETFs
Index funds are passive mutual funds that try to replicate the performance of an underlying index or benchmark.
ETFs on the other hand are similar to index funds, as they have the same objective of replicating the performance of the underlying benchmark or asset class. But the key differentiating factor is that ETFs are bought and sold on an exchange just like stocks.
So, you can invest in an index fund just like any other mutual fund but you will need a DEMAT account to invest in an ETF. This is the basic difference between the two instruments.
If you are somebody who doesn’t have a DEMAT account then index funds are the option for you. But if you are a DEMAT account holder or are planning to open one, you may want to explore the two options and select the best for yourself.
For this, we will compare the performance of a NIFTY 50 Index Fund with a NIFTY 50 ETF.
But before starting with the comparison process let’s understand the concept of tracking error. We will be using this metric to compare the performance of NIFTY 50 Index funds and NIFTY 50 ETFs
What Is Tracking Error?
Tracking Error measures how well the index fund is able to replicate the underlying index. It is calculated using the difference in returns of the index and the difference in returns of the fund. The more effective a fund is in replicating the index, the lower the tracking error. Hence, it’s better to have a low tracking error.
There are multiple reasons why there is a difference in the performance of an Index fund and three of them are
- An expense ratio of the fund: AMCs incur some costs when they run a fund. These can be gauged through the expense ratio of a fund. The higher the expense ratio, the higher can be the tracking error of the fund.
- Cash balance of the fund: All funds maintain some cash balance to ensure liquidity in the fund. This liquidity is important to cater to the redemptions in the fund. This leads to some difference in the fund’s returns and the underlying index’s returns
- Impact of buying and selling stocks: The stocks which AMC wants to add can be illiquid which may lead to a difference in its returns vis-a-vis the underlying index. Further, they may have to buy it at a higher price because their buying volume moves up the price.
Now, having understood the concept of tracking error, we can move toward the comparison part.
First we will look at different NIFTY 50 index funds and select one fund to be compared with an ETF.
Selecting Best Performing Nifty 50 Index Fund
In the table below, we have looked at top 5 index funds which track the NIFTY 50 index (Based on AUM)
| Comparison Of NIFTY 50 Index Funds | ||||
| Scheme | Expense Ratio (In %) | Tracking Error (5 year) | 5 Year CAGR Returns | 5 Year CAGR of Benchmark |
| UTI NIFTY 50 Index Fund | 0.20 | 0.088 | 12.00% | 12.31% |
| HDFC Index Fund – NIFTY 50 Plan | 0.20 | 0.094 | 11.94% | 12.31% |
| ICICI Prudential NIFTY 50 Index Fund | 0.17 | 0.094 | 11.89% | 12.31% |
| SBI NIFTY Index Fund | 0.18 | 0.101 | 11.78% | 12.31% |
| Nippon India Index Fund – NIFTY 50 Plan | 0.20 | 0.094 | 11.90% | 12.31% |
Source: Value ReseData as of 18 Jan 2022
Above schemes are direct-growth plansarch, Ace MF
From the table above tracking error of the UTI NIFTY 50 Index Fund is the lowest and the fund has returns that are closest to the benchmark returns. Hence, we can select this fund for our comparison.
Similar to the above, we need to select one of the best-performing NIFTY 50 ETFs too for comparison.
Selecting Best Performing Nifty 50 ETF
We have followed a similar approach to select one of the best-performing ETFs as we did above. with Index funds.
In the table below we have looked at the Top 5 ETFs (Based on AUM) which are tracking the NIFTY 50 Index.
| Comparison Of NIFTY 50 ETFs | ||||
| ETF Options | Expense Ratio (in %) | Tracking Error (5 Years) | 5 Year CAGR Returns | 5 Year CAGR of Benchmark |
| SBI NIFTY 50 ETF | 0.07 | 0.086 | 12.17% | 12.31% |
| UTI NIFTY 50 ETF | 0.07 | 0.087 | 12.16% | 12.31% |
| Nippon India ETF NIFTY 50 BeES | 0.05 | 0.085 | 12.21% | 12.31% |
| ICICI Prudential NIFTY 50 ETF | 0.05 | 0.086 | 12.18% | 12.31% |
| HDFC NIFTY 50 | 0.05 | 0.087 | 12.18% | 12.31% |
*Data as of 18 Jan 2023
Source: Value Research, ACE MF
Similarly, here also tracking error of Nippon India ETF NIFTY 50 BeES is the lowest and its returns are closest to the benchmark. So we can select this for our comparison.
Now that we have filtered out one NIFTY 50 ETF and one NIFTY 50 Index fund, we can look at our primary question – Which is better: the NIFTY 50 ETF or the NIFTY 50 Index Fund?
For this let’s compare them on
- Returns Generated
- Tracking Error
Comparing NIFTY 50 ETFs and NIFTY 50 Index Fund
The table below indicates the returns generated by UTI NIFTY 50 index fund and Nippon India ETF over different time frames
| Returns of UTI NIFTY 50 Index Fund & Nippon India ETF NIFTY 50 BeEs | ||
| CAGR Return(in %) | UTI NIFTY 50 Index Fund | Nippon India ETF NIFTY 50 BeES |
| 1 Year | 1.34 | 1.55 |
| 3 Year | 14.66 | 14.87 |
| 5 Year | 12.00 | 12.21 |
| 10 Year | 12.54 | 12.79 |
*Data as of 18 Jan 2023
The returns of the ETF are slightly higher than the returns of the index fund. Let’s look at their expense ratio and their tracking error too.
| Ratios of UTI NIFTY 50 Index Fund & Nippon India ETF NIFTY 50 BeEs | ||
| Ratios | UTI NIFTY 50 Index Fund | Nippon India ETF NIFTY 50 BeES |
| Tracking Error (5 Year) | 0.088 | 0.085 |
| Expense Ratio | 0.20 | 0.05 |
*Data as of 18 Jan 2023
From the above tables, Nippon India ETF NIFTY 50 BeES has a lower tracking error, lower expense ratio, and slightly higher returns.
So, are ETFs an obvious choice over NIFTY 50 Index funds?
Not Exactly, there are some caveats. Let’s look at them
Limitations Of NIFTY 50 ETFs
There are some limitations which are applicable to all the ETFs. Those limitations apply to NIFTY 50 ETFs too. Specifically, there are 2 limitations that are relevant to our discussion here.
- ETFs are bought and sold just like stocks. So there are other charges which have to be paid by the investors. These include transaction charges, GST on transaction charges, SEBI charges, and stamp duty.
- End of the day NAV of the ETF can be different from the price at which you invested.
Let’s understand the above using one example. Let’s assume you are an active investor.
- On 17th July 2022, when NIFTY corrected to the 15,300 level you bought 1,000 units of Nippon India ETF NIFTY 50 BeES at Rs 167 each.
- On 1 Dec 2022, when NIFTY reached the 18,800 level you thought markets were overvalued and sold your investments at Rs 205 per unit.
If you look at the return excluding the transaction costs, it comes out to be 22.75%. However, when you take into account the brokerage and other transaction costs, your net returns reduce to 22.47%. This illustrates that transaction cost reduces returns in an ETF to some extent.
Now let’s look at the second limitation- the price at which you invested can be different from the end-of-the-day NAV of the ETF.
In the same example, the returns on the basis of the NAV of the ETF come out to be approximately 23%. And the returns by UTI NIFTY 50 Index Fund would also have been approximately 23%. So, you earned lower returns because the price at which you invested was higher than the NAV of the ETF on that day. However, the flip of this is also true. Sometimes the price at which you buy the ETF can be lower than the NAV of that day and you can earn higher returns.
The purpose of doing the above exercise was to illustrate that even though ETFs have higher returns than index funds, the returns which are generated for an investor get reduced when we consider transaction costs. Also, the returns an investor gets from ETFs can be different from the returns generated by the same ETF calculated on a NAV basis. This difference can be used to your advantage or can be a disadvantage too.
Bottom Line
So, the answer to the question – should you choose NIFTY 50 ETF over NIFTY 50 Index Funds—depends on your investor personality.
If you wish to utilize the opportunities when Index corrects during market hours but recovers by end of the day, then ETFs are your option.
However, most of us are passive investors and follow the SIP route. If you do an SIP, it is much easier to go with index funds, rather than ETFs. Further, there can be a case where you want to liquidate your holdings but there is not enough liquidity in the ETFs at your desired price. If you want to avoid such problems then you can invest in index funds.
Therefore, you can choose the option which aligns with your investor personality. If you wish to invest in index funds, you can explore ET Money
