Which Nifty, Nifty Next 50, Sensex index funds have lowest tracking error?

Which index funds have the lowest tracking error

Published: October 9, 2019 at 10:19 am

Last Updated on

Let us find out which index funds tracking the Nifty, Sensex or Nifty Next 50 have the lowest tracking error using a simple and easy to understand method. If there is enough interest, I shall publish this report from time to time. We shall restrict the discussion to index funds for now.

ETF tracking error also is essential, but it will have to be done with respect to its price and not NAV (as is usually reported). Actual investor returns are based on ETF price and not NAV, and therefore, all calculations should be done with the price. Here is an example: ICICI Nifty Next 50 Index Fund vs Reliance ETF Junior BeEs. A more dramatic illustration of the price effect is seen here: ETFs vs Index Funds: Stop assuming lower expenses equals higher returns!

I realised historical ETF price data is available at Moneycontrol only just before completing this article. Therefore I have not included ETFs here but shall do so in another post shortly. Also, I have only included Nifty, Sensex and Nifty Next 50 index funds for this study. The rest have too short a history to warrant consideration.

The job of an index fund manager is to track a given index. This may seem easy at first, as there is no active stock selection involved. However, the fund will be subjected to in and outflows and therefore, must have a small amount of cash.  Corporate actions like splits and dividends will have to be accounted for. Considering all this, making sure the portfolio weights of individual stocks match closely to that of the index is not as easy as it seems.  Then there are expenses to worry about. You can consult this excellent introduction to tracking error by the NSE.

Thus the NAV movement of an index fund will always trail behind the price of the underlying index. A good fund manager will minimise this lag. A measure of this lag is known as tracking error.

Tracking error is defined as the standard deviation of the daily difference between the fund return and index return: lower this value, the better. Very few people bother to understand that the tracking error depends on the duration of the calculation. A one-year tracking error can be quite different from a three-year tracking error.

Therefore, a more straightforward and more comfortable to understand check of index fund performance is necessary. I prefer to compare 1,2,3,4 and 5 years (or longer) returns of the index funds with the returns of the total returns index. A fund with a consistently low return difference has small tracking error.

Nifty Index Funds with lowest tracking error

Let us start with the trailing returns of Nifty index funds.

NIfty Index fund trailing returnsNow we calculate the difference between scheme return minus index return. This must be negative. If this is positive for any duration, immediately reject the fund! See, for example, these five index funds beat their indices! Why you should avoid them!

Join our 1500+ Facebook Group on Portfolio Management! Losing sleep over the market crash? Don't! You can now reduce fear, doubt and uncertainty while investing for your financial goals! Sign up for our lectures on goal-based portfolio management and join our exclusive Facebook Community. The 1st lecture is free! Did you miss out on the lockdown discount? You can still avail it! Follow instructions in the above link!

Nifty index funds return difference tableThe funds highlighted in green above have a return difference lower than the median return difference. This means that they are in the top half of the pile.  Investors can choose a fund with sizeable AUM among these and low expense ratio.

Since the expense ratio keeps fluctuating, one cannot infer past tracking performance based on the current expenses. Also shown above is only the trailing return data. Rolling returns can provide a better picture. I shall include this next time.

To reiterate, we have defined tracking error as consistently low return difference between the fund and index over the last 1,2,3,4 and 5 years. This is easier for investors to calculate on their own, is more comprehensive (as opposed to computing last 3Y daily returns based tracking error) and most importantly, natural to understand.

Nifty Next 50 Index funds with lowest tracking error

List of Nifty Next 50 Index Funds with lowest rturn differenceICICI Nifty Next 50 fund has a good track record. The UTI fund has impressed over the last year. As an investor, you can undoubtedly go for it. As an analyst, more time is necessary to judge it.

Sensex Index Funds with lowest tracking error

 

Here the HDFC fund had an active management past. HDFC Sensex plus fund was merged with HDFC Sensex fund. So its history cannot be considered. The Tata fund has impressed in this window but has too low an AUM (~ 11 Crores)

Summary

Return comparison of the index fund with index (total returns) is a simple and easy way to measure tracking performance. This can be immediately done at most fund portals. Notice that the return difference will be more than the expense ratio of the fund. This is because expenses are only one factor that contributes to tracking error.

An efficient fund manager of a slightly expensive index fund can still “outperform”  a less expensive index fund! Bottom line, index funds require “active” management too! If there is enough interest in such a study, I shall repeat it for ETFs also.

Do share if you found this useful
Share your thoughts on this topic at the  Reddit freefincal_user_forum

Reach your financial goals like a pro! Join our 1600+ Facebook Group on Portfolio Management! You can now reduce fear, doubt and uncertainty while investing for your financial goals! Sign up for our lectures on goal-based portfolio management and join our exclusive Facebook Community. The 1st lecture is free!
Want to check if the market is overvalued or undervalued? Use our market valuation tool (will work with any index!) or you buy the new Tactical Buy/Sell timing tool!
About the Author Pattabiraman editor freefincalM. Pattabiraman(PhD) is the founder, managing editor and primary author of freefincal. He is an associate professor at the Indian Institute of Technology, Madras. since Aug 2006. Connect with him via Twitter or Linkedin Pattabiraman has co-authored two print-books, You can be rich too with goal-based investing (CNBC TV18) and Gamechanger and seven other free e-books on various topics of money management. He is a patron and co-founder of “Fee-only India” an organisation to promote unbiased, commission-free investment advice. He conducts free money management sessions for corporates and associations on the basis of money management. Previous engagements include World Bank, RBI, BHEL, Asian Paints, Cognizant, Madras Atomic Power Station, Honeywell, Tamil Nadu Investors Association. For speaking engagements write to pattu [at] freefincal [dot] com
About freefincal & its content policy Freefincal is a News Media Organization dedicated to providing original analysis, reports, reviews and insights on developments in mutual funds, stocks, investing, retirement and personal finance. We do so without conflict of interest and bias. We operate in a non-profit manner. All revenue is used only for expenses and for the future growth of the site. Follow us on Google News Freefincal serves more than one million readers a year (2.5 million page views) with articles based only on factual information and detailed analysis by its authors. All statements made will be verified from credible and knowledgeable sources before publication. Freefincal does not publish any kind of paid articles, promotions or PR, satire or opinions without data. All opinions presented will only be inferences backed by verifiable, reproducible evidence/data. Contact information: letters {at} freefincal {dot} com (sponsored posts or paid collaborations will not be entertained)
Connect with us on social media
Our publications

You Can Be Rich Too with Goal-Based Investing

You can be rich too with goal based investingPublished by CNBC TV18, this book is meant to help you ask the right questions, seek the right answers and since it comes with nine online calculators, you can also create custom solutions for your lifestyle! Get it now. It is also available in Kindle format.
Gamechanger: Forget Startups, Join Corporate & Still Live the Rich Life You Want Gamechanger: Forget Start-ups, Join Corporate and Still Live the Rich Life you wantThis book is meant for young earners to get their basics right from day one! It will also help you travel to exotic places at low cost! Get it or gift it to a young earner

Your Ultimate Guide to Travel

Travel-Training-Kit-Cover-new This is a deep dive analysis into vacation planning, finding cheap flights, budget accommodation, what to do when travelling, how travelling slowly is better financially and psychologically with links to the web pages and hand-holding at every step. Get the pdf for Rs 199 (instant download)
Free android apps