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What is an index fund and how to identify the most profitable ones?

Date: December 9, 2023 Time: 21:09:14

Mutual funds are collective investment products. In other words, investors make contributions that make up the fund’s assets and make them participants. However, when investing in a fund, the investment guidelines are not in the hands of the investors. The CNMV explains that the fund is created by an entity, the manager, “which is the one that jointly invests these contributions in different financial assets -fixed income, variable income, derivatives or any combination- following guidelines set beforehand.”

Each participant owns a part of the fund’s assets, in proportion to the value of their contributions. The value of his contribution will vary depending on the increases or decreases in the value of the assets according to the evolution of the investments. Before investing, those interested can find out about the investment strategy and the type of assets in which the fund invests -investment policy- in the so-called informative brochure.

Investment funds are a savings instrument that allows savers to deposit their money in the financial market, but with the management of professionals and without follow-up work and attention to the investment. In addition, its tax treatment is more favorable than other financial products. But within investment funds there are different types and it is important to know which one we are going to invest in.

replicator and index

Usually, when investing, one of the objectives is to beat the market. That is, achieve a higher return than the market average. However, there is a type of investment fund that seeks to follow the market, specifically, an index. They are index funds. According to Bankinter’s Clear Finance Dictionary, an index investment fund is “an investment fund whose investment strategy is to replicate a reference index, usually variable income”.

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That is, they are going to invest by copying the composition of the index that is taken as a reference. For example, an investment fund indexed to the Ibex 35, the main stock market index of the Spanish stock market, must invest in the 35 companies that make it up and in the same proportion that they represent in the index. In the case of the Spanish index, according to the latest data published by BME, 15% would have to be invested in Iberdrola, 12% in Inditex or 10.5% in Santander.

passive management

From Bankinter they explain that the function of replicating an index makes its management cheaper. For this reason, index funds are cheaper than actively managed ones. It is one of the main characteristics of index funds, they are based on passive management. The CNMV defines it as the “portfolio management modality with which it is intended to obtain a return equivalent to that of the reference index or indices, through a choice of securities that replicates its evolution.”

For its part, active management is a “portfolio management style that seeks to outperform an index or benchmark asset by taking advantage of market inefficiencies; To do this, we use the selection of undervalued assets and the identification of the best moment to buy or sell.”

In search of profitability

Although its objective is to replicate an index, as in any type of investment, it also seeks to maximize profitability. To know the current most profitable ones, it is enough to look at the actual profitability of the indices. For example, among the most relevant worldwide, since the beginning of the year the Nasdaq, the US index that brings together the 100 most important technology companies, has appreciated almost 30%. The 35% Spanish Ibex, for its part, has gained 16% since January. Likewise, there are many indices by country, sector or company size, among other factors.

However, it must be borne in mind that, as with any investment, past returns do not guarantee future ones. The choice should not be conditioned solely by past returns because, as the CNMV points out, “it is not a guarantee of future returns”.

* This website provides news content gathered from various internet sources. It is crucial to understand that we are not responsible for the accuracy, completeness, or reliability of the information presented Read More

Puck Henry
Puck Henry
Puck Henry is an editor for ePrimefeed covering all types of news.

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