Building a passive-only portfolio with index funds

Thanks to the advent of the internet, more and more people now have access to information that helps them invest in various investment options other than the traditional ones. However, with many of these options, you may need to dedicate substantial efforts and a considerable amount of time to get started. For instance, to invest in stocks directly, you should be able to pick the right stocks, invest at the right time, and then monitor your investments on a regular basis. You may need more bandwidth for this, especially if you have a full-time job. Here is where passive investing may be able to help you. It is an approach in which your portfolio is based on another composition, such as an index. Moreover, index funds may be considered the ideal option for passive investing.
Read on to know how you can build a passive-only portfolio composed of index funds.

What is a passive portfolio?
A passive portfolio is one in which your assets are passively managed. The common ingredient of a passive portfolio is a passively managed mutual fund. A passive strategy is the inverse of an active one. The goal of active investing is to beat the market, and the fund manager or portfolio manager goes to great lengths to conduct the necessary research on companies and select stocks with a higher potential to beat the benchmark.

By contrast, in a passively managed fund, the goal is not to beat the benchmark but to mimic the benchmark’s growth. For this purpose, passively managed funds track an index instead of having a portfolio curated by a fund manager. For instance, a fund that tracks the Nifty 50 has the same composition as the index.

Index funds could be the suitable option for you if your aim is to create a passive portfolio.

What are index funds?
Index funds are mutual funds that track an index. The composition of such a fund’s portfolio is identical to that of the index it tracks.

A prominent advantage of investing in an index fund is its lower fee. Because an index fund replicates the performance of its underlying benchmark, fund managers do not require a strong research department to assist them with stock selection. Moreover, there is no active trading. This means that the expense ratio of index funds tends to be low.

Moreover, because index funds use a mechanized, regulation-based investing approach, the fund manager is given a clear mandate of how much money should be invested into which index fund of which security. This eliminates the possibility of error or prejudice arising from investing decisions made by the fund manager.

Now that the working of index funds is clear, let us take a look at how you can build a portfolio.

• Large-cap index funds
Large-cap index funds may add stability to your portfolio. Large-cap funds invest in large-cap companies. These companies are huge and may offer greater stability. Similarly, the large-cap component in your passive portfolio can ensure that your investment potentially remains safe during periods of market volatility.

A prudent choice here could possibly be a Nifty or Sensex index fund. Both indexes are composed of the top companies in India, and all of these companies are large-cap companies.

• Mid-cap index funds
Mid-cap index funds may serve as another valuable addition to your portfolio. These funds invest in companies with mid-sized market capitalization. Despite their volatility, midcaps have historically provided investors with superior long-term returns. Nifty Midcap 150 and Nifty Midcap 50 are the options you may consider here. Because of their advantageous position between the extremes of large and small-cap companies, mid-caps may be able to provide superior returns in the pursuit of growth. When deciding whether to buy into a mid-cap business, investors should consider the company's revenue growth quality.

• Small-cap index
The funds replicate the performance of small-cap indices. They represent a cost-effective route to invest in equities as well. However, not everyone may do well with small-cap funds. This is because of the lower trading volumes associated with small-cap stocks compared to those of their larger counterparts. Moreover, small-cap stocks tend to have larger insider ownership levels, resulting in lower availability of capital for external investors. However, small-cap index funds may have the potential to provide superior returns relative to those of mid- and large-cap index funds. This is because many small-cap funds are in their growth stage, and there are more chances for accelerated growth.

• Asset allocation
The three types of funds described above are the main index fund options available to investors. Apart from these, there are sectoral funds which track the growth of a sector index. However, the equity mixes of such funds could be different. Regardless, the next step is to design your portfolio. Your asset allocation could be based on two factors, as follows:

1) Your investment goals
2) Your risk tolerance

For instance, if your goal is to create a retirement fund, you could invest in an investment option that has a longer time horizon. Similarly, if you are conservative about your investments, you could consider staying away from small-cap funds.

Conclusion
Creating a passive portfolio by using the above pointers could help you achieve your goals without stressing over the investing and monitoring process. Regardless, it is important that you are well aware of the nuances of these funds, including the tracking error, to achieve better results.

Note: Market caps are defined as per SEBI regulations as below: a. Large Cap: 1st -100th company in terms of full market capitalization. b. Mid Cap: 101st -250th company in terms of full market capitalization. c. Small Cap: 251st company onwards in terms of full market capitalization.

Note: Views and opinions contained herein are for information purposes only and should not be construed as investment advice/ recommendation to any party or solicitation to buy, sale or hold any security or to adopt any investment strategy. It does not warrant the completeness or accuracy of the information and disclaims all liabilities, losses and damages arising out of the use of this information. The recipient should exercise due caution and/ or seek professional advice before making any decision or entering into any financial obligation based on information, statement or opinion which is expressed herein.

Statutory Details: Axis Mutual Fund has been established as a Trust under the Indian Trusts Act, 1882, sponsored by Axis Bank Ltd. (liability restricted to Rs. 1 Lakh). Trustee: Axis Mutual Fund Trustee Ltd. Investment Manager: Axis Asset Management Co. Ltd. (the AMC). Risk Factors: Axis Bank Limited is not liable or responsible for any loss or shortfall resulting from the operation of the scheme. No representation or warranty is made as to the accuracy, completeness or fairness of the information and opinions contained herein. The AMC reserves the right to make modifications and alterations to this statement as may be required from time to time.

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