Which Nifty Index Fund has the lowest tracking error?

Last Updated on January 10, 2021 at 6:43 pm

We find out which Nifty Index Fund has the lowest tracking error over the last six years. Readers may recall that we have earlier shown that lower expenses do not mean lower tracking error! We have also earlier looked at return differences for different durations for various index funds.

Announcement: To help new investors get started the right way, I am planning a free seminar on portfolio management covering the absolute basics. You can sign up via this Google Form. The link will be emailed to you.

For new index investors: If you are new to the world of index funds then these resources may be of help: How to select an index fund (do you really need one?). To understand the primary differences between ETFs and index funds, you could consult: Nippon India ETF Nifty BeES vs UTI Nifty Index Fund: Which is better?

What is a tracking error? How is it determined? An index fund tracks an underlying benchmark. Due to expenses related to fund’s management, fund’s in- and out-flows, corporate actions associated with stocks – dividends, split, buybacks etc. there will be a deviation between the fund returns and benchmark returns. A measure of how much the fund has deviated is called the tracking error.

You may have heard of the standard deviation. This is a measure of volatility. In other words, it tells us how much the fund’s return (daily, weekly, monthly etc) measured over a few years has deviated from the average return(daily, weekly, monthly etc).

Higher the standard deviation, higher the volatility. Volatility is the standard deviation of individual fund return minus average fund return. Tracking error is the standard deviation of individual fund return minus individual benchmark return.

For an index fund, there is only the NAV and there is no problem computing the tracking error. For the ETF, the price is what the investor pays on buying and selling. Unfortunately, both returns and tracking error of an ETF is computed using NAV and not the actual price. This can lead to huge differences as shown before: ICICI Nifty Next 50 Index Fund vs Reliance ETF Junior BeEs

ETFs are also subject to impact costs. That is, the buying price and selling price depends on the number of units sold. A trader buying selling a few ETF units may not feel any difference between the buying and selling price. However, if you have been buying ETF units without redeeming anything significant for years and want to sell units worth lakhs for your goal, then you notice an appreciable difference. You would not be able to sell them freely.  This is the main reason Indian ETFs are better suited for trading than investing.

Investors incorrectly believe that since an ETF has only half the expense ratio of an index fund, they would have lower tracking error and better returns. This is not true at all as shown before: ETFs vs Index Funds: Stop assuming lower expenses equals higher returns! For the typical retail investor, an index fund is a simpler, safer product. Safer because, if they are not careful while buying and selling it can lead to significant losses.

Update Nov 2020: Tracking error data is now updated monthly. Get the data for free here: MF screener (look for posts tracking error in the title)

List of Nifty Index funds studied

1. UTI Nifty Index Fund
2. IDBI Nifty Index Fund
3. HDFC Index Fund-NIFTY 50 Plan
4. ICICI Pru Nifty Index Fund
5. SBI Nifty Index Fund
6. Nippon India Index Fund – Nifty Plan
7. IDFC Nifty Fund
8. LIC MF Index Fund-Nifty Plan
9. Tata Index Fund-Nifty Plan
10. Franklin India Index Fund-NSE Nifty
11. Aditya Birla SL Index Fund
12. Taurus Nifty Index Fund
13. DSP NIFTY 50 Index Fund

Nifty index funds from L&T and Motilal Oswal are less than a year old and are not considered. We shall list below the top five funds – those with lower tracking error over the last 1,2,3,4,5,6 year periods with respect to July 8th 2020. The data is sourced from ACE MF.

The tracking error data is tabulated below. For easier reading, the main results are presented first.

• IDBI Nifty Index Fund and UTI Nifty Index Fund are the clear winners. Taking the first two positions.
• Amusingly or perhaps astonishingly the current expense ratio of the IDBI fund is 0.3% three times more than the UTI fund. Fund here refers to the direct plan fund only.
• The IDBI fund has an AUM of only 181 Crores while the UTI fund, 2147 Crores.
• The third-place goes to HDFC Index Fund-NIFTY 50 Plan (1621 Crores, 0.11% and fourth to ICICI Pru Nifty Index Fund (851 Cr, 0.1%)

These numbers reiterate what we have been saying for years. Tracking errors do not correlate with expenses. Do they correlate with the actual experience of investors? Minimal return difference between the fund and its index? Let us find out.

The last few years trailing returns of the above-mentioned funds are tabulated below.

Now we shall only at the return differences. That is the index return minus fund return.

The UTI Nifty Index Fund has remained in the top-3 in terms of lowers return differences along with ICICI Pru Nifty Index Fund. The UTI fund being the better performer more often. This correlates with low tracking error found above.

However, aside from the last two years, the IDBI Nifty Index Fund has not done as well. This does not correlate with tracing error and is quite possibly due to higher expenses and low AUM

HDFC Index Fund-NIFTY 50 Plan has also done well with the exception of the last couple of years.

Summary: We once again urge investors to look at such return differences while shortlisting index funds. HDFC Nifty Index fund is also a reasonable contender for consistently low tracking expenses along with UTI Nifty fund. The ICICI fund is just behind.

Appendix:  Tracking error data for the top five funds over the last 1,2,3,4,5,6,7 years is tabulated below.

Nifty Index Fund Tracking Error Last Seven Years

Nifty Index Fund Tracking Error Last Six Years

Nifty Index Fund Tracking Error Last Five Years

Nifty Index Fund Tracking Error Last Four Years

Nifty Index Fund Tracking Error Last Three Years

Nifty Index Fund Tracking Error Last Two Years

Nifty Index Fund Tracking Error Last One Year

Update Nov 2020: Tracking error data is now updated monthly. Get the data for free here: MF screener (look for posts tracking error in the title)