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Index mutual funds are mutual funds that mimic and track a market index like Nifty 50 or Sensex. They provide diversification and exposure to the broader market at low costs. Index funds have become quite popular over the last decade due to their simple strategy, low fees, and ability to generate good returns over long periods. However, not everyone in India parks their money in index funds despite their benefits. Read on to understand the reasons why index funds have not become universally adopted by investors in India.
Lack of awareness
One of the biggest reasons holding back wider adoption of index funds is simply a lack of awareness. Index investing is still a relatively new concept in India. Actively managed funds have been around for decades and are more popular. Many investors are just not aware of how index funds work, their benefits, and performance history. Robust investor education by fund houses and regulators can help improve awareness. The low-cost structure also means less marketing by fund companies who spend more promoting actively managed funds.
Preference for active fund management
Investors have traditionally preferred active fund management where the fund manager handpicks stocks to try and beat benchmarks. Actively managed funds are perceived as having a chance to outperform through stock selection skills of the fund manager. This is despite data showing most active funds unable to beat index returns over long periods. But the preference persists. Ironically, access to more information today reinforces this tendency as investors track short-term performance.
Skepticism of automated investing
Some old-school investors may be skeptical of the very idea of automated index investing that removes human judgment and stock picking. They prefer an expert fund manager carefully selecting stocks. The debate between active and passive investing continues globally. However, data shows most fund managers unable to beat market indices over 10–15-year periods. Still, some investors are unwilling to believe index funds can match or exceed active fund returns over long periods.
Lack of index fund choices
While the index fund market has grown significantly in India, there is still a lack of variety and choice compared to active funds. Very few fund houses offer index funds tracking niche sectors and segments. For some investors, this limits the appeal of parking a sizable portion of their portfolio in index funds. However, as awareness and AUM grow, fund houses are launching more targeted index funds.
Concerns about downside protection
Some investors may worry about index mutual funds' ability to protect capital during market downturns. Since index funds stay fully invested at all times tracking the benchmark, they can magnify losses during bear markets. Actively managed funds have the flexibility to reduce equity exposure and raise cash to curb losses. However, over full cycles, most active funds still underperform the index. Holding some debt funds can hedge index funds downside.
Conclusion
Lack of awareness, preference for active management, skepticism of automated investing, insufficient product choice, downside concerns etc. are some of the reasons index funds face adoption challenges. However, with continuing education and the passage of time, index funds are likely to become a larger part of investor portfolios. Their long-term track record and low costs make them compelling.