Hugs are great! When you’re feeling blue and you get a tight hug from a loved one, you instantly start to feel great. Hugs are also a great way of welcoming some into your life and building relationships with them. Don’t believe us? Ask our beloved and honourable Prime Minister. He’s known to hug his foreign counterparts and not only that, he was also surprised with a hug from the Congress President last year!
Indeed, hugs are great. Almost always. Hugs are not so great if it’s your equity mutual fund hugging an index. Yes, there’s a term called ‘Index Hugger’ that refers to an active mutual fund that performs pretty much like an index. An index is a collection of stocks that are selected based on pre-defined rules - for example, the Nifty-50 index is comprised of the 50 largest companies (measured by market-capitalisation) listed on the NSE.
Funds termed as “Index Huggers” are typically actively-managed equity mutual funds that are supposed to beat their benchmark index with handsome margins. These funds charge a fee for this performance. But while the fee gets paid, the outperformance doesn’t happen. Such funds are called index huggers.
Index huggers are especially common among defined cap equity funds (i.e. large-cap, mid-cap, or small-cap). Since a majority of the corpus of such funds have to be invested in stocks in that segment, it is likely to have the same allocation similar to its benchmark index. In such cases, an investor is paying for active management but not really receiving it.
So, let’s see how you can check if your equity fund is an index hugger:
- Check the fund’s portfolio and compare the holdings with its benchmark
- Check the fund’s returns to see if it has actually outperformed the benchmark over various time periods
If the fund has been able to beat the index consistently and considerably, then you’re probably in good hands. Else, here’s what you should do if you are holding an index hugger:
- Exit the fund
- Choose another actively-managed fund if you’re looking to beat the market, but do consider the costs
- Or, choose an index fund, ETF, or smallcase if you’re looking to passively build wealth at low costs
ETFs and smallcases, by the way, are a great way to passively invest for the long-term. They’re low-cost, can be tracked at their real-time price and deliver returns that can be relied upon.
If your equity fund is hugging an index, it makes more sense to invest in an ETF or a smallcase and hug the index yourself. At a much lower cost too!