Top 5 mid-cap index funds with lowest tracking error and benchmark-like returns

Tracking error remains a key measure to track an index fund’s performance. It measures how closely an index fund or ETF replicates the returns of its benchmark index. A lower tracking error generally indicates that the fund is more closely aligned with the performance of the underlying index.

Since mid-cap index funds track mid-cap indices, tracking error is an important factor to consider before investing. So, let's take a look at the top 5 mid-cap index funds with the lowest tracking error.

What are mid-cap index funds?

Mid-cap index funds are a type of index fund that replicate the performance of mid-cap indices such as the NIFTY Midcap 150 by holding the same stocks in similar proportions.

Mid-cap stocks are shares of companies having a market capitalization between ₹5,000 crore and ₹20,000 crore. These companies are ranked 101st to 250th on stock exchanges based on their total market capitalization.

Mid-cap index funds provide exposure to mid-sized companies that have the potential to deliver strong long-term growth. Since they are passively managed, they typically have lower expense ratios than actively managed funds.

Why checking tracking error is important

Tracking error is a measure of how closely an index fund follows its benchmark index. It is calculated as the standard deviation of the difference between fund returns and index returns over a specific period, since the primary objective of an index fund is to replicate its benchmark.

Generally, a lower tracking error indicates better fund management and more efficient index replication.

Top 5 mid-cap index funds by lowest tracking error

Here is the list of the top 5 mid-cap index funds by lowest tracking error you can consider.

Key factors to consider while investing in mid-cap index funds

Apart from tracking error, there are other market-related factors you can consider before investing in mid-cap index funds.

Mid-cap segment performance

One important factor to consider is the performance of the mid-cap segment relative to the broader market. If the mid-cap segment has been in a prolonged downturn, say, for more than three years, investors can exercise caution.

Portfolio allocation

Since index funds track a benchmark index, it is useful to review the index's constituents. This review can include examining the top five or 10 holdings of both the index and the fund, along with their respective weightings. If the index's largest holdings experience sustained volatility, it may affect the fund's performance and contribute to a higher level of investment risk.

PE ratio

Valuation is an important consideration across the large-, mid- and small-cap segments. If the underlying mid-cap index is trading at elevated valuations, it may increase the risk associated with investing in index funds tracking that index.

Sector concentration

The underlying mid-cap index may have varying sector exposure, including financials, industrials and healthcare. Reviewing the sector allocation can help assess whether the index is concentrated in a few sectors, which may influence its performance during periods of sector-specific weakness.

Disclaimer: This is purely for educational/ informational purposes and should not be taken as any sort of investment advice. Always consult a SEBI-registered advisor before making any investment decisions.