Investing

Index Funds VS Bluechip Funds

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Over the past year, everybody is talking about the performance of Index funds in the year 2018 and how index funds actively outperformed large cap funds.

In 2018, Nifty 50 Index funds gave 4% returns while other large cap funds experienced lower funds comparatively. Not just the figures but also the industry experts are suggesting that investors choose index funds over large cap schemes. If you are confused between the two, read on to select the perfect scheme for yourself as per your financial needs.

First let us understand what are Index Funds and Bluechip Funds. 

What are Index Funds ?

So Index funds are basically a portfolio of stocks or bonds which replicates the composition of and performance of Financial Market Index such as Nifty, Sensex etc. 

What are Bluechip Funds?

A bluechip fund is one that invests only in the top performing companies and the stocks of such companies are known as Blue Chip stocks.

Now let’s understand the difference between bluechip fund and Index Funds 

  • A bluechip fund basically tracks the popular and well performing top companies like AstraZeneca, Reliance, HSBC and BP etc to name a few. While an Index fund tracks the actual Index like London stock exchange.
  • As share market keeps rising, except the odd times, we can say that index funds are much safer when compared to the blue chip funds as many blue chip companies have business cycles. 
  • Blue chip funds are actively managed funds which means the fund manager decides out of the available companies which company he should invest in. 

Whereas Index Funds are passively managed funds which means that there is no option to choose from, and basically composition of an index is followed.

  • Bluechip funds have a large scope of outperformance or underperformance but that’s not the case with index funds.
  • Fund managers in the case of a bluechip fund are actively taking the decisions of stocks which is not possible again in the case of an index fund. 
  • Bluechip funds have a higher expense ratio whereas index funds have lower expense ratio.
  • Bluechip fund managers are actively working hard to get the maximum returns out of any stock whereas index funds are completely dependent on the market index.

Therefore, when understanding the differences between the two it transpirers that should the Fund Manager manage the funds very well and his predictions are correct, most of the time if not every time, then the bluechip funds have a huge scope of outperformance and can get you really good returns in the long run. But on the other hand if the fund manager makes a mistake in their comprehension of the market, then there is huge possibility that the blue chip will give you lower returns as compared to the Index funds. 

What are the advantages and disadvantages of index and bluechip funds?

Advantages of Index Funds

  • Diversification – Diversification is one of the major benefits when it comes to the Index Funds as your portfolio becomes immensely diversified. 

So when you have your investment in a number of stocks then in that case even if one or two stocks goes down it will not affect your overall portfolio much. Whereas if you have all your money invested in one stock and the value of the stock goes down, you will lose a large amount.

  • Low Costs- Every mutual fund including Index Funds has an Expense Ratio, which is the annual fee charged to its shareholders.

As Index Funds are passively managed funds the Fund Manager has very little work to do. They therefore charge a lot less compared to actively managed funds and this saving is then passed down to you in the form of lower expense ratio.

Advantages of Blue chip Funds

  •  Stable cash flows and consistent dividends – The word ‘blue chip’ comes from the game of Poker where a blue chip holds the highest value. As the name suggests blue chip stocks are the shares of established large companies which are in the market for quite a long time and as a result these highly valued and well known companies benefit the investors over the long run and provide stable cash flows and consistent dividends.
  • Stock stability – Blue chip funds are considered the safest when the economy is not doing so well, because of their steady nature. Most blue chip companies will have experienced teams which help the company to generate a stable income even during  the harsh market conditions.
  • Fast recovery – When the broader stock market enters a bearish phase, even then these blue chip companies are less volatile than the smaller companies and will have a faster recovery when the market eventually recovers. 

Disadvantages of Index Funds 

  • Lack of Downside Protection – Stock markets are the first choice for investor who wants to invest for a longer period of time. But over the years, it has experienced many ups and downs. Investment in Index funds depends on the market performance, you will be at the upside when the market is doing well, but it will leave you unprotected when the market falls.
  • Limited Exposure – Investors have used several strategies over the years with great success, but when buying Index funds you can find it’s particularily difficult to access many of these strategies. Strategies can be combined to gain low risk adjusted returns for the investors, therefore thorough research may enable access to better value stocks. Once you are done with your research, combine them for a targeted portfolio, this way you will be able to create a better positioned portfolio, which is suited to your goals and risk tolerances.

Disadvantages of Blue chip funds

  • Moderate growth – Blue chip stock shows very slow growth potential as these companies are already successful so there are less or very limited chances of growth. Whereas mid cap companies show high growth potential as these are still in their development stage. Although the average blue chip shares may increase over time but the growth rate is likely to be slow. This slow growth rate may upset investors who expect good average growth in a short duration.
  • Focus on Dividends over Growth – Blue chip stocks tend to focus more on dividends than growth as investors enjoy a steady income from their investment in the form of dividends. When it comes to building wealth for oneself, dividends are not at all helpful. Growth stocks are the best option to build capital at a faster rate. 

Investors who want to build wealth over medium to long term, large cap funds are the best investment option compared to index funds. However, a beginner can start with an index fund who is looking for equity exposure and understands the equity market well. Index funds can be a good choice for most of the investors but may not be a good decision for everyone. There are both risks and benefits of index funds that you should be aware of before investing.

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