There are currently 32 index funds with at least one-year history as on Jan 28th 2021. If we compare their one-year trailing returns with the respective benchmark (total return indices), six index funds are outperforming! That is, their one-year return is higher than than the one-year index return!
Why does this happen? Although the stocks in an equity index fund are well known and there is no research involved in the selection, adjusting the index fund portfolio weights to closely match that of the index is not an easy job.
Even if we considered a closed-ended index fund where there no daily investments and redemptions, tracking the index is a hard enough job, everyday prices moves would need to be accounted for. There are corporate actions like dividends, and expenses will have to be deducted daily.
In an open-ended index fund, daily AUM movement in and out of the fund adds a tracking complexity layer. Such funds will always hold a small amount of cash to handle these transactions.
There will always be some difference in returns between the index fund and its index. Ideally, we expect the index fund return to be lower than that of the index because of expenses and the cash holding. Typically tracking errors from other sources will either enhance or reduce this return difference.
If the index fund return is greater than the index return, then the tracking error is so high that it has eliminated the effect of expenses and the cash holding. This typically happens if the portfolio is too volatile (e.g. higher turbulence, mid cap or small cap segments) and/or the AUM is too low (a single large investment or redemption can result in a significant tracking error).
The last year (29th Jan 2020 to 28th Jan 2021) a period when we woke up to the coronavirus news and how it gradually crippled our economy and subsequent stock market recovery was a turbulent period. This is a stringent tracking test of index fund managers.
When there is increased market turbulence, it would be hard for the fund manager to buy or sell large quantities of stocks due to higher impact costs (a natural gap between bid and sell price). See Warning! Even “large cap” stocks are not liquid enough! Can you handle this?
The last 1Y return difference = Index fund return minus index return is shown below. The first six index funds have positive return differences. Some extreme underperformance is also seen at the bottom of the table. Low AUM and the impact cost associated with stocks beyond the top 50 in terms of market cap is likely to be the reason for this as well. Readers may compare the funds in “red” with our previous list published almost two years ago: These five index funds beat their indices! Why you should avoid them!
List of Index Fund One-year return differences
| Scheme Name | Difference |
| Taurus Nifty Index Fund(G)-Direct Plan | 0.9887 |
| Motilal Oswal Nifty Midcap 150 Index Fund(G)-Direct Plan | 0.5903 |
| Motilal Oswal Nifty 50 Index Fund(G)-Direct Plan | 0.4057 |
| Franklin India Index Fund-NSE Nifty(G)-Direct Plan | 0.3458 |
| IDFC Nifty Fund(G)-Direct Plan | 0.2805 |
| ICICI Pru Sensex Index Fund(G)-Direct Plan | 0.2714 |
| Motilal Oswal Nifty Smallcap 250 Index Fund(G)-Direct Plan | -0.0553 |
| Nippon India Index Fund – Sensex Plan(G)-Direct Plan | -0.1850 |
| Tata Index Fund-Sensex Plan(G)-Direct Plan | -0.2918 |
| Axis Nifty 100 Index Fund(G)-Direct Plan | -0.3286 |
| Motilal Oswal Nifty Bank Index Fund(G)-Direct Plan | -0.3309 |
| ICICI Pru Nifty Index Fund(G)-Direct Plan | -0.5095 |
| UTI Nifty Next 50 Index Fund(G)-Direct Plan | -0.5097 |
| IDBI Nifty Index Fund(G)-Direct Plan | -0.5344 |
| LIC MF Index Fund-Sensex Plan(G)-Direct Plan | -0.5576 |
| UTI Nifty Index Fund(D)-Direct Plan | -0.5752 |
| Motilal Oswal Nifty 500 Fund(G)-Direct Plan | -0.5819 |
| Tata Index Fund-Nifty Plan(G)-Direct Plan | -0.6290 |
| HDFC Index Fund-Sensex(G)-Direct Plan | -0.6371 |
| Nippon India Index Fund – Nifty Plan(G)-Direct Plan | -0.6682 |
| Aditya Birla SL Index Fund(G)-Direct Plan | -0.7106 |
| HDFC Index Fund-NIFTY 50 Plan(G)-Direct Plan | -0.7965 |
| DSP NIFTY 50 Index Fund(G)-Direct Plan | -0.8666 |
| LIC MF Index Fund-Nifty Plan(G)-Direct Plan | -0.9038 |
| SBI Nifty Index Fund(G)-Direct Plan | -1.0791 |
| ICICI Pru Nifty Next 50 Index Fund(G)-Direct Plan | -1.1352 |
| DSP Equal Nifty 50 Fund(G)-Direct Plan | -1.3228 |
| DSP NIFTY Next 50 Index Fund(G)-Direct Plan | -1.4033 |
| Motilal Oswal Nifty Next 50 Index Fund(G)-Direct Plan | -1.4524 |
| IDBI Nifty Junior Index Fund(G)-Direct Plan | -1.4834 |
| Sundaram Smart NIFTY 100 Eq Weight Fund(G)-Direct Plan | -2.8004 |
| Principal Nifty 100 Equal Weight Fund(G)-Direct Plan | -3.1605 |
How to select index funds
Not all index funds are the same. Investors should keep in mind fund size (AUIM) expense ratios and actual return differences. Interested readers can refer to our guides on index fund selection:
- Nifty Next 50 Index Funds with lowest tracking error
- Three Nifty index funds with lowest tracking error
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