MF Query Board

Readers are requested to send only one query at a time so that more readers get a chance. Have questions relating to any aspect of personal finance. Ask DSIJ at editorial@DSIJ.in and get your queries resolved  

Which are the index funds with the lowest tracking error? - Mohan Jagtap

An index fund replicates indices such as the Sensex or Nifty by holding the same stocks in the same proportions. You might argue that it’s an exact clone of the index that it is tracking. According to Securities and Exchange Board of India’s circular on mutual fund rationalisation and categorisation, index funds are those with at least 95 per cent of their total assets invested in the securities of a certain index. However, there is no index fund on the market that can provide you with the precise return of the index it is tracking. There is a phenomenon called as tracking error as mentioned by you in your query. So, in this case, you should look at the tracking error, which displays how much the returns stray from the index being tracked.

The lower the tracking error, the better it is. There may be a variation in return because they have the option to invest 5 per cent at their discretion. A passive investing approach works over time but because India is a developing market there are several possibilities for the fund manager to produce alpha over the index against which it is benchmarked. However, strictly in terms of cost, if you are interested in investing in an index fund, an exchange traded fund (ETF) is preferable. This is a less expensive alternative to index funds. To choose the best index fund, look for one with the lowest tracking error among its peers as well as one with a lower cost ratio. As a result, a fund that ranks lower in both categories may turn out to be the best index fund. Given below is a list of the top five index funds with the least tracking error.

What are the different kinds of returns calculated in mutual funds? - Shabbir Ahmed

There are absolute returns or point-to-point returns. Absolute returns just assist you in calculating the returns on your initial investment. You simply need the initial net asset value (NAV), which is the NAV at which you first invested, and the current NAV of the plan to calculate this. In point-to-point returns, the holding time is not used. For example, assume that your NAV at the time of your initial investment was 20 and is now 40 after three years. As a result, the absolute return in this case is 100 per cent. Absolute returns are calculated as Current NAV – Original NAV/Original NAV x 100. This is simple to compute in Excel.

However, keep in mind that computing the returns of SIP in this method will result in the absolute return of the single SIP. Similarly, you must calculate the absolute returns of all SIPs that you have completed and then take an average to obtain the absolute returns of all SIPs. If you use it for more than a year, it will not give you the correct picture. Further, annual compound growth rate (CAGR) is an absolute return but with a holding period. CAGR would be a more useful measure of return than absolute returns. Even if you look at the fact sheet of any mutual fund, the returns above one year are presented as CAGR and the results below one year are given as absolute returns. CAGR simply represents the consistent rate of return on your assets throughout the specified time period.

It simply removes the volatility from the equation and returns the average yearly growth rate. You may compute it as follows: CAGR = [(Current NAV/Original NAV) (1/N)] – 1 x 100, where N is the number of years. If your holding duration is in months, then replace 1/N with 12/N assuming all other elements remain constant. Similarly, if the holding time is on a daily basis, replace 1/N in the foregoing calculation with 365/N. If you want to calculate the CAGR of a SIP, do the same thing you did for absolute returns: calculate the CAGR for each SIP and then take the average to get the CAGR of the SIPs. However, neither absolute returns nor CAGR would prove to be the best measure to calculate SIP returns.

You can also use XIRR to calculate returns. Calculating returns based on absolute returns and CAGR might be ineffective when dealing with unpredictable financial flows, both inflows and outflows. So, in this case, we must compute XIRR. XIRR is nothing more than an internal rate of return or an annualised rate of return on a series of cash flows that occur at irregular intervals. This is the best way for calculating SIP returns because SIPs are not like lump sum investments where you only invest once. SIP is a long-term investment in which the units are redeemed as and when they are needed. To calculate XIRR, you will need Microsoft Excel, the date your SIPs were invested, the day you redeemed all of your units and the amount you earned after redeeming all your units. The XIRR function in Excel will produce the necessary output.