According to Value Research, the real cost of owning a passive index fund is not the headline expense ratio but rather tracking error. Daxesh Kothari, managing director and chief executive of Ashutosh Financial Services, explains that while passive investing is supposed to mean picking one low-cost index fund and leaving it alone, many investors still feel the urge to switch. Kothari emphasizes that a cheaper fund is not automatically a better one, and the actual cost of ownership lies in the gap between the fund's performance and its benchmark index. Recent market data shows that even funds with excellent NAV-based tracking error of just 0.02% can still show tracking error of 1.77% when measured against actual market price, driven by bid-ask spread and trading costs that the headline expense ratio never captures.
As reported by Value Research, Kothari outlines a systematic approach for when switching a passive fund is genuinely worth it and when it is just a costly reflex. He recommends watching a tracking gap for a longer period before acting, explaining that one year is not enough time to assess performance consistency. The framework involves weighing potential savings against exit loads and capital gains tax implications, ensuring that any switching decision is based on meaningful data rather than short-term market movements. Recent analysis confirms that comparing expense ratios across different categories (such as gold ETFs versus Nifty 50 ETFs) is not meaningful, as these are fundamentally different products with different cost structures.
According to the report, constantly chasing the latest sectoral or thematic index fund can turn a passive portfolio into an active one. Kothari warns that this approach defeats the purpose of passive investing, which is designed to eliminate the need for frequent fund switching. The analysis suggests that investors should focus on long-term tracking error performance rather than short-term market timing strategies to maintain the passive investment philosophy effectively. Recent market trends show that broad equity index ETFs tracking Nifty 50 or Sensex have experienced genuine fee competition, with the most competitive offerings charging as little as 0.02% to 0.05% annually, a figure that has trended down over time as more fund houses compete for the same, largely undifferentiated product.
