Types of Index Funds

 Broad Market Index Funds

A Broad Market Index Fund tries to replicate a large segment of the investible stock market. For instance, an Index Fund tracking the NIFTY 500 index is a Broad Market Index Fund because it gives investors exposure to stocks across different sectors and market caps.

One such example is the Motilal Oswal NIFTY 500 Fund. Another example is the Navi Total Market Index Fund which will give investors exposure to 750 stocks across large-cap, mid-cap, small-cap, and even micro-cap companies.

Globally also there are multiple Index Funds. In fact, a good chunk of investment in Index Funds in the US goes into their broad market funds like the Wilshire 5000 Total Market Index Fund, the Russell 3000 ETF, and the Vanguard Total Stock Market Index Fund.

To sum up, Broad Market Index Funds simply look to capture the total performance of the stock market. And therefore, they are an excellent investment option for long-term investors.

Nonetheless, if you invest in a Broad Market Index and you also invest in other Index Funds, then there is bound to be some overlap in the holdings. This overlapping cannot be avoided. But you should not be particularly bothered with the overlapping as long as you are diligently tracking your overall asset allocation across large, mid, and small-cap companies, irrespective of whether you are investing via Mutual Funds or stocks

2. Market Capitalization Index Funds

Size does matter. It is an aphorism that is deeply entrenched in our society. And more so when it comes to investing. A majority of the available indices are weighted by their market capitalization. For instance, the NIFTY 50, the SENSEX, the NIFTY Next 50, the NIFTY Midcap 150, NIFTY Smallcap 250, and the NIFTY 200 are all examples of indices that are market-cap weighted.

Stocks often go through ups and downs. In that context, almost every stock is overvalued or undervalued at any given point in time. In other words, a market cap index gives a higher weight to an overvalued stock and a lower weight to an undervalued stock. So, every additional rupee that gets invested in an Index Fund adds more fuel to the existing distortion. This ends up disproportionately increasing the price of some stocks at the expense of others. Another way to look at it is that Index Funds are partly responsible for extending bull runs by making stocks more and more expensive.

Nonetheless, when these expensive stocks become unsustainably expensive, it eventually leads to a quick and deep market-wide correction. But again, if you are a long-term investor, short-term volatility shouldn’t be a major concern.

3. Equal Weight Index Funds

One way to counteract the over and under weighted-ness of a market-cap weighted index is to go for an equal-weight index. Simply put, an equal-weight index is an index where every stock in the index carries the same weight. For instance, say the index under consideration is NIFTY 50. In that case, all the 50 companies are conceptually weighted at an equal 2%.

In other words, consider an equal weight index like a perfectly balanced ship that is looking to avoid the storms that are often created by price momentum or valuation biases. Traditionally, an equal weight index is more value-oriented. Also, an equal weight index is certainly a lot more diversified as compared to the market-weighted index.

A case in point is the NIFTY 50 index. Here is a table that shows how the equal-weight NIFTY 50 index is a lot more diverse in terms of its holdings and sectoral allocation, as compared to the market-cap-weighted NIFTY 50 index.

4. Factor-Based Or Smart Beta Index Funds

The market capitalization approach is the most popular way of creating an index. But it need not be the only way. Other attributes like the PE ratio, dividend yield, book value, cash flow, sales, etc., can also serve as worthy metrics to build an index. And these metrics can probably do a better job of identifying attractively valued companies to an index portfolio

Today’s computers are a lot more powerful and are quite capable of learning from complex data streams and financial metrics. It is these insights that are then categorized into neatly packaged characteristics called factors. These factors then go by the labels of value, momentum, quality, volatility, etc.

Recently, factor-based Index Funds have started gaining traction. You might even have heard of some factor funds in another name as “smart beta funds”. Now, most smart-beta funds that are being launched in India consist of a single factor.

For example, the Edelweiss NIFTY 100 Quality 30 index uses the quality factor. This factor is a concoction of multiple metrics like the Return On Equity (ROE), the return on capital, the company’s operating cash flows, the debt in the company, etc. Similarly, there are Index Funds and ETFs that use the volatility factor, value factor, momentum factor, etc.

Lately, Mutual Fund companies have also launched some multi-factor funds i.e. Index Funds that use 2 factors and sometimes even 3 factors. These multi-factor Index Funds aim to offer a more comprehensive investing option by managing returns, risk, and volatility in a more efficient manner.

Here are some examples of factor-based Index Funds and ETFs.

Edelweiss NIFTY 100 Quality 30

ICICI Prudential NIFTY Low Vol 30

Kotak Nv20

ICICI Prudential Nv20

Nippon India NIFTY 50 Value 20

UTI NIFTY 200 Momentum 30

ICICI Prudential Alpha Low Vol 30 (Two Factor Index)

5. Strategy Index Fund

Strategy index funds replicate strategy indices which in turn are constructed using quantitative models and investment strategies. For example, one of the strategic indices that exist is the NIFTY dynamic asset allocation index. This index series primarily consists of 2 indices – NIFTY 50 & short duration debt – dynamic P/E, and NIFTY 50 & short duration dynamic P/B Index. 

These indices track multiple asset classes, mainly equity, and debt, and assign weight to the asset class based on their valuation measured using the price-to-earning ratio (P/E) or price-to-book ratio (P/B). Hence, it can be suitable for investors who want to have a lower allocation to equity when it’s overvalued and vice versa.

6. Sector-Based Index Funds

Many investors invest in sector-based funds or ETFs. The idea is to invest in businesses belonging to the same industry or sector. For example, there are sector-specific Index Funds and ETFs in banking, technology, healthcare, infrastructure, consumption, etc.

These sectoral funds generally cater to broader categories. But there are Index Funds with a much narrower and more specific mandate. For instance, a banking sector Index Fund is based on the broader banking category, but investors can also choose a PSU bank-only or a private bank-only Index Fund.

The Indian investment industry has seen quite several launches in this space over the last few months. And it is a category that can grow at an accelerated pace.

7. International Index Funds

Earlier in the year, there were barely 3 or 4 passive international funds. But the last 8 months have seen a spate of offerings in the International Index Funds space. Now, funds are tracking multiple US-specific indices such as the NYSE FANG+ index, the S&P 500 index, and the NASDAQ index.

There are also a couple of funds that track the Hang Seng Index. You can also have access to some of the developed market indices that operate in isolation or as a combination of funds.

8. Debt Index Funds

There are two major risks that you can face when you invest in debt instruments. One, the price of bonds goes up and down due to changes in interest rates. This is called the interest rate risk.

And secondly, the credit risk i.e. the probability of some bonds defaulting because of the issuer of the bond failing to make the payment.

Debt-based Index Funds are not among the most popular products in India. But there are Debt Index Funds like target maturity Index Funds that can be quite useful in mitigating the interest rate risk and credit risk in your portfolio.

Take, for example, the recently launched ICICI Prudential PSU Bond Plus SDL 40:60 Index Fund – September 2027. This is a passively managed scheme that replicates a custom index that consists of 8 AAA-rated PSU bonds and 20 State Development Loans in a 40-60 ratio.

Now, while the scheme is open-ended, this Debt Index Fund comes with a maturity date, which in this case, is the 30th of September 2027. So if an investor stays invested until maturity, then the interest rate risk is eliminated. And since the investments are going into PSU bonds & AAA instruments, the credit risk is largely negligible.

Debt index instruments are getting popular now with many fund houses launching schemes in this category. For instance, Aditya Birla Sun Life NIFTY SDL Plus PSU Bond Sep 2026 60:40 Index Fund and Edelweiss NIFTY PSU Bond Plus SDL Index Fund 2026 are similar to the investment strategy of ICICI Prudential PSU Bond Plus SDL 40:60 Index Fund – Sep 2027. Edelweiss also manages the Bharat Bond Index which is a low-cost, passively managed instrument that invests in AAA-rated public sector bonds.

Similarly, Axis Mutual Fund has a bond fund, Nippon India Mutual Fund has multiple funds, and IDFC Mutual Fund, too, has a few GILT Index Funds that invest only in government securities.

9. Custom Index Funds

A standard index operates on a “one size fits all” model. But as more data processing power gets unleashed, it helps create a pathway for a lot more personalization based on what the fund manager wants and what different investor groups seek. This is where custom indices come in to picture.

Simply put, Custom Index Funds allow institutions and advisory firms to create their own set of investing strategies under a passive framework. Think of it like the architect giving you a basic set of blueprints but allowing you to tweak the construction per your specific requirements.

Now, custom indexing, although not mainstream, has started to find its feet. Many global financial institutions are adopting it against the backdrop of progressive technologies and zero or low commission trading fees. There is much warmth towards building custom indices among Indian Mutual Fund companies as well. And these funds are likely to be more popular in the next 3, 4, 5 years from now.