Tracking errors continue to hurt index funds

Since March 9, the Bombay Stock Exchange Sensitive Index, or Sensex, has risen 70 per cent (till Friday). However, index funds continue to have tracking errors.

Index funds are supposed to mirror the underlying index. That is, they have the same stocks as the Sensex or the Nifty, and in the same proportion.

Tracking error occurs when the scheme’s returns are less/more than that of the underlying index. Internationally, a tracking error of up to 0.5 per cent is acceptable. In India, this could be slightly higher at 1 per cent, said fund managers. Most funds continue to have a tracking error of more than 0.5 per cent. Many have errors of over 1 per cent. And some even exceed 2 per cent and 3 per cent.

For instance, ICICI Prudential SPIcE’s and HDFC Index Sensex have returned 66.47 per cent and 66.56 per cent, respectively, which means tracking errors of 3.43 per cent and 2.74 per cent, respectively, between March 9 and May 22, according to data from Value Research, a mutual fund research agency.

Some funds that have managed to stay within the 1 per cent limit are Tata Index Sensex A (0.9 per cent), UTI Master Index 0.96 per cent and Franklin India Index NSE Nifty (0.28 per cent).

Swati Kulkarni, fund manager in UTI Asset Management Company, said, “We have a small cash holding with us in the index fund. It has a small deviation from the benchmark index. Even our expense ratio is very low, that is, our AMC fees is 0.75 per cent.”

Industry experts said there were mainly three reasons for tracking errors. “High cash levels, change in the composition of the index and mismatch between the daily change in the weight of stocks and the scheme’s weights lead to tracking errors,” said Rajan Mehta, director, Benchmark Mutual Fund. Market experts say higher expenses also bring down the returns.

However, fund managers claimed there was little interest in these schemes. Milind Barve, CEO, HDFC Asset Management said, “In India, institutional money does not come into index funds because they prefer active management.”