Index funds and ETFs
Two ways to hold a whole index in one scheme, what each costs, and what neither can do
Industry figures as on 31 August 2026
Verified 12 October 2026
For training and education only. Not investment advice.
Trainer notes
Ask the room: if the Nifty 50 falls 15% this year, what happens to a Nifty 50 index fund? Take answers and keep them for slide 9. Many people expect a passive fund to be protected in some way. It is not.
A passive fund does not try to beat its index. It tries to match it, less costs.
Nobody picks the shares. The index decides what the fund holds and how much of each. So the fund rises when the index rises and falls when the index falls.
Trainer notes
Passive investing means following a published index instead of relying on a fund manager's choice of securities. The opposite is an actively managed fund, where the manager chooses. This deck does not say which is better; it explains how the passive kind works.
Three terms to get right
Index
A list of securities chosen by a published rule, with a weight for each. The Nifty 50 is one. An index is a calculation. It cannot be bought directly.
Index fund
A mutual fund scheme that holds the index's securities in the index's weights. Units are bought from, and sold back to, the fund house at NAV.
ETF
Exchange traded fund. The same kind of portfolio, but the units are listed. Investors buy and sell them on a stock exchange at a market price.
Take-away: Both are mutual fund schemes. Each must keep at least 95% of its assets in the securities of its index.
Source: SEBI Master Circular for Mutual Funds, 20 Mar 2026, para 3.8.5 (Index Funds/ETFs: minimum 95% in securities of the index).
Trainer notes
NAV is net asset value: the value of what the scheme holds, less what it owes, divided by the number of units. An index fund or ETF can track an index of shares or bonds, or the price of a commodity such as gold or silver; this deck mostly uses share indices as examples. SEBI places index funds and ETFs under 'Other Schemes' in its categorisation.
Index fund and ETF, side by side
| Index fund | ETF | |
|---|---|---|
| Where you deal | With the fund house, directly or through a distributor. | On a stock exchange, through a stock broker, in trading hours. |
| Price you get | The day's NAV, worked out after the market closes. One price a day. | The market price at that moment. It can be above or below the NAV. |
| Accounts needed | A folio with the fund house. No demat account is needed. | A demat account and a trading account with a broker. |
| What keeps it in line | The fund house itself issues and cancels units at NAV. | Market makers exchange large blocks, called creation units, with the fund house and quote prices on the exchange. |
| Costs outside the fund | Stamp duty of 0.005% on purchases. Exit load, if the scheme has one. | Broker's and statutory charges, and the gap between buying and selling quotes. |
Source: SEBI Master Circular for Mutual Funds, 20 Mar 2026, paras 4.5.1, 4.5.2 and 4.5.9; stamp duty from Trustner Academy fact sheet, 7 Oct 2026.
Trainer notes
Which NAV an index fund investor gets depends on the cut-off time and on the money reaching the fund. For an ETF, the exchange shows an indicative NAV during trading hours; for equity ETFs it is updated within 15 seconds of the underlying market. An investor can deal directly with the fund house in an ETF only for more than ₹25 crore; market makers are exempt from that floor. Statutory charges on exchange trades also apply to ETFs.
Tracking difference: the gap in return
ONE YEAR, ASSUMED
The index, with dividends counted, returns 12.00% in a year.
An index fund tracking it returns 11.55%.
A person holds ₹1,00,000 in the fund at the start.
- Tracking difference = fund return − index return = 11.55% − 12.00% = −0.45 percentage point.
- At the index's return, ₹1,00,000 would have become ₹1,12,000. Nobody can hold the index itself, so this is only a yardstick.
- In the fund it became ₹1,00,000 × 1.1155 = ₹1,11,550. The gap is ₹1,12,000 − ₹1,11,550 = ₹450.
- The gap comes mainly from the fund's expenses, the cash it keeps for redemptions, and the cost and timing of its own trades.
Result: Tracking difference is the fund's return minus the index's. Here it is −0.45 point: 0.45 given up.
Illustration with assumed figures. Not a forecast, and not the return of any index or scheme.
Trainer notes
SEBI defines tracking difference as the annualised difference of daily returns between the index and the NAV of the ETF or index fund. Every index fund and ETF discloses it monthly on the fund house's and AMFI's websites for 1, 3, 5 and 10 years and since allotment. It is usually negative but can occasionally be positive. The comparison is with the total return index, which counts dividends.
Tracking error: how steady the gap is
FIVE DAYS, ASSUMED
Each day, take the fund's return minus the index's return.
Over five days the differences are +0.02%, −0.02%, +0.02%, −0.02% and 0.00%.
- The average of the five differences is 0.00%. On average the fund kept pace over these days.
- Square each difference and add them up: 4 × 0.0004 = 0.0016. Divide by 4, one less than the five days: 0.0004.
- The square root of 0.0004 is 0.02. So the daily standard deviation of the difference is 0.02%.
- To put it on a yearly scale, multiply by the square root of 250 trading days (assumed), about 15.81: 0.02% × 15.81 = about 0.32%.
Result: Tracking error measures how much the daily gap wobbles. Lower means a steadier gap, not a smaller one.
Illustration with assumed figures. A real tracking error uses a full year of daily data.
Trainer notes
SEBI defines tracking error as the annualised standard deviation of the difference in daily returns between the index and the NAV, on rolling one-year data. It is disclosed daily on the fund house's and AMFI's websites. For index funds and ETFs other than debt ones it must not exceed 2%, except in force majeure situations, which go to the trustees. The 250 trading days used here is an assumption for the arithmetic. A fund can have a small tracking error and still a large tracking difference, if it lags by a steady amount every day.
What a passive fund costs
The cap: 0.90%
SEBI caps the base expense ratio of an index fund or ETF at 0.90% a year. A scheme may charge less. Each discloses its own ratio.
On top of the base
Brokerage and transaction costs on the fund's trades, and statutory levies such as GST, are charged on top of it under the 2026 Regulations.
Outside the fund
Index fund: stamp duty of 0.005% on each purchase. ETF: broker's and statutory charges, and the buy-sell quote gap, on each trade.
Take-away: Assumed example: at an expense ratio of 0.20%, ₹1,00,000 held for a year bears about ₹200 of expenses.
Sources: SEBI (Mutual Funds) Regulations, 2026, regulations 66-67; Trustner Academy fact sheet (investments), 7 Oct 2026.
Trainer notes
The base expense ratio covers the management fee and the scheme's running expenses. The total expense ratio is the base ratio plus brokerage, transaction costs and statutory levies. Expenses are taken out of the scheme's assets every day, so the investor never sees a bill; the cost shows up as tracking difference. The 0.20% in the example is assumed; ₹1,00,000 × 0.20% = ₹200, and it is 'about' because the charge is on each day's assets.
What an index fund cannot do
Step aside in a fall
It stays invested. If the index falls 20%, ₹1,00,000 in the fund becomes about ₹80,000, less costs. Nobody moves it to cash.
Beat its index
Its aim is to match. After expenses it usually ends a little behind the index, which is what the tracking difference records.
Choose what it holds
It holds what the index holds, in the index's weights. A narrow or top-heavy index gives a narrow or top-heavy fund.
Take-away: Passive describes how the securities are chosen. It says nothing about how far their prices can fall.
Trainer notes
Return to the opening question. The 20% fall is an assumed figure: ₹1,00,000 × (1 − 0.20) = ₹80,000. The same applies to an ETF. Returns are not assured in any passive scheme. When the index changes its members at a periodic review, an equity index fund or ETF must rebalance within 7 calendar days.
Where passive assets stand
Index funds and ETFs in India at the end of August 2026. AMFI publishes these figures every month.
- PASSIVE AUM, ₹ LAKH CRORE
- 15.4217.7% of the industry's ₹87.08 lakh crore. Up 26.5% in one year.
- ETFS, ₹ LAKH CRORE
- 11.97Includes equity ETFs ₹8.18 lakh crore and gold ETFs ₹1.91 lakh crore.
- INDEX FUNDS, ₹ LAKH CRORE
- 3.45Equity index funds ₹2.51 lakh crore; debt index funds ₹0.94 lakh crore.
- FOLIOS, CRORE
- 5.55Folios in index funds and ETFs, of 28.35 crore in all. Not investors.
Source: AMFI Monthly Note, August 2026 (month-end assets and folios; 'passive' means index funds and ETFs). The 17.7% share is computed from the same table.
Trainer notes
AUM is assets under management. Exact figures: passive ₹15,41,732 crore of ₹87,07,888 crore; ETFs ₹11,96,850 crore; index funds ₹3,44,882 crore; folios 5,55,16,090. State the figures and the date and stop. Past growth is not a forecast. AMFI notes that gold ETF assets rose largely with the price of gold. Refresh these from the AMFI Monthly Note each month.
If you learnt this from older material
What older decks say
- Tracking error is the one number to look at.
- Any large investor can deal with the fund house.
- Authorised participants (old term) supply liquidity.
- Passive funds track share indices or gold.
What holds now
- Tracking error is disclosed daily and tracking difference monthly.
- Only for more than ₹25 crore. Others trade on the exchange.
- Each ETF must have at least two market makers.
- Debt, silver and hybrid index products also exist.
Source: SEBI Master Circular, 20 Mar 2026, paras 4.2 and 4.5.1-4.5.8, citing circulars of 24 Nov 2021, 23 May 2022, 28 Jul and 28 Oct 2022 and 31 Dec 2024.
Trainer notes
The idea has not changed; the rules, the disclosures and the range of products have. The disclosure rules, the 2% tracking error limit and the market-making framework come from SEBI's circular of 23 May 2022. The ₹25 crore floor comes from circulars of 28 July and 28 October 2022 and does not apply to market makers. Silver ETFs date from a circular of 24 November 2021 and hybrid index funds and ETFs from one of 31 December 2024. The expense cap also changed: from 1 April 2026 it is a base expense ratio of 0.90% with levies on top.
Four things people get wrong
Misconception'Passive means low risk.'
What is trueA passive fund carries the full market risk of its index. An index of smaller companies moves like smaller companies.
Misconception'An ETF trades at its NAV.'
What is trueIt trades at a market price. With a NAV of ₹250 and a price of ₹251, the buyer pays a premium of 0.40%.
Misconception'An index fund equals the index.'
What is trueIt usually trails by its costs. Compare the fund with the total return index, which counts dividends as well as prices.
Misconception'Two funds on one index are the same.'
What is trueExpense ratio, tracking difference and tracking error differ from scheme to scheme. For ETFs, so does trading volume.
Trainer notes
Premium arithmetic: (251 − 250) ÷ 250 = 0.40%. A price below NAV is a discount. If an ETF's closing price stays more than 1% below NAV for 7 trading days in a row, investors may redeem up to ₹25 crore directly with the fund house without exit load; two other triggers also open this window.
Check yourself
Question 1: An index returns 9.00% in a year, dividends included. An ETF tracking it returns 8.70% on NAV. What is the tracking difference, and the rupee gap on ₹2,00,000?
Answer: 8.70% − 9.00% = −0.30 percentage point. ₹2,00,000 × 1.09 = ₹2,18,000 at the index's return; ₹2,00,000 × 1.087 = ₹2,17,400 in the ETF. The gap is ₹600.Question 2: An ETF's NAV is ₹400.00 and its units are trading at ₹398.00. Is that a premium or a discount, and how large?
Answer: A discount. (400 − 398) ÷ 400 = 0.50%.Question 3: A client says: 'I am in an index fund, so I am protected if the market falls.' What would you explain?
Answer: An index fund stays invested in its index. If the index falls, the fund falls by about the same percentage, less costs. Passive describes how the securities are chosen, not the level of risk. Returns are not assured.
Sources and disclaimer
Sources for the figures in this explainer
- Passive, ETF, index fund and industry assets and folios, 31 August 2026: AMFI Monthly Note, August 2026.
- 95% minimum in index securities; market makers, creation units, ₹25 crore floor: SEBI Master Circular for Mutual Funds, 20 March 2026, paras 3.8.5 and 4.5.1 to 4.5.3.
- Tracking error and tracking difference, 7-day rebalancing, indicative NAV: same Master Circular, paras 4.5.4, 4.5.5 and 4.5.9.
- Base expense ratio cap of 0.90%: SEBI (Mutual Funds) Regulations, 2026, regulations 66-67, in force 1 April 2026.
- Stamp duty of 0.005%; no demat account for an index fund: Trustner Academy verified fact sheet and scheme-types lesson, 7 October 2026.
- Returns, NAVs, prices and expense ratios in the worked examples are assumed. They do not refer to any real index or scheme.
This material is for training and investor education only. It is not investment, tax or legal advice and is not a recommendation to buy, sell or hold any security or scheme. Examples use assumed figures unless a source and date are shown. Mutual fund investments are subject to market risks; read all scheme related documents carefully. Trustner Asset Services Pvt. Ltd. is an AMFI-registered Mutual Fund Distributor (ARN-286886).