Mutual Funds: Why should investors consider broad market index funds?

The robust growth of India’s economy has a direct correlation with the performance of its equity markets. As sectors like services and agriculture expand, they boost investor confidence, leading to increased market participation and higher valuations. This positive sentiment in the equity markets, in turn, encourages further investment in these growing sectors, creating a virtuous cycle of economic and market growth.

In the last decade, India’s equity markets have shown impressive growth. The BSE Sensex, which stood at around 25,000 in 2014, has tripled to approximately 75,000 by 2024. Similarly, the Nifty 500 has increased more than 2 times over the last 5 years. Despite periods of volatility, the Indian equity market’s resilience and growth trajectory has been noteworthy.

India boasts a diverse investment landscape, from established financial giants to innovative startups. But navigating this vastness can be challenging. Here's how investing in broader market index funds empowers you:

Diversification matters to reduce risk

Imagine putting all your eggs in one basket. If that basket falls, so does 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 any single company or sector experiencing a downturn. Therefore, when investors gain exposure to a broader index that captures the wider spectrum of the Indian economy, they are poised to benefit from it.

Broad market index funds achieve this by holding a basket of companies across various sectors and market capitalizations. This inherent diversification eliminates the need for actively picking individual stocks, reducing the risk associated with any single company's performance.

Exposure to growth potential and market dynamism

Beyond established large-cap companies, broader market indices encompass exciting mid and small-cap companies. These represent the future of the Indian economy, brimming with innovation and the potential for high growth. By investing in a broad market index fund, investors stand to gain automatic exposure to this untapped potential alongside the established giants. Furthermore, by spreading investments across different sectors, investors tend to become less vulnerable to downturns in any single industry.

Markets are inherently dynamic, with sectors and companies taking turns leading the growth charge. Broad market index funds, by design, are constantly adjusting to reflect this dynamism. They automatically rebalance as companies' market capitalizations change, ensuring the portfolio stays aligned with the evolving market landscape.

Understand risk as a spectrum, and not binary

Instead of a binary win-or-lose scenario with individual stocks, broader market funds expose investors to a spectrum of opportunities. The inherent diversification across sectors and market capitalizations means a poor performer in one area can be offset by strong gains in another. This

allows investors to observe the market's historical risk-reward spectrum, providing valuable context for their own investment decisions.

In fact, it would not be too much of a stretch to state that the very nature of a broad market index is that it inherently balances risk and reward. This allows one to experience the market's overall risk-reward profile.

A simplified approach for the long term

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

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

Source: NSE, BSE, Axis MF Internal Research as on 20th June 2024

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

Vikash Wadekar, Head Passives, Axis Mutual Fund