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Franklin Templeton cautions about `tracking error'

Our Bureau

KOLKATA, Feb. 21

FRANKLIN Templeton, which is set to launch an index-linked tax saving scheme, wants investors to be familiar with the `tracking error' that index funds are likely to commit while mirroring indices of their choice.

Franklin India Index Tax Fund, which opens for subscription on February 26, would provide tax benefits under Section 88 of the Income-Tax Act. Subject to tracking error, it would seek to attain results commensurate with NSE Nifty.

The scheme would not attempt to outperform the market, but would be as good as the index it proposed to track. That forms the crux of the message that Franklin Templeton is trying to convey to investors.

Tracking error, it may be mentioned here, could occur due to variation between the returns of an index fund and the index itself. A stock market index, according to the MF, is calculated on daily closing prices. The fund, however, would need to transact in securities at different times during a trading session at prevailing rates.

Also, tracking error could occur because of the fund's inability to buy or sell exact quantities -- often due to illiquid market conditions.

Franklin Templeton has also informed that the introduction of Index Futures on NSE has helped address the issue of transacting in relatively illiquid situations. Moreover, the beginning of post-close trading facility on the exchange would increase the fu nd's ability to chase the index more accurately.

The MF has also taken pains to point out that the Nifty is ``one of the most scientific indices in India'', managed as it is by India Index Services & Products Ltd, a joint venture between NSE and Crisil, with technical assistance from Standard & Poor's. This company focuses on Nifty (more formally, the S&P CNX Nifty) as its core product, and owns and operates the index.

As on February 1, 2001, its top constituents included HLL, Infosys, Reliance, Reliance Petro and ITC -- all of which (and the 45 others) were blue-chip, large-cap, liquid and highly-traded counters.

Tracking errors, it may be mentioned here, are a fact of life for all other index funds. Two of these are managed by UTI (one each for Sensex and Nifty), while IDBI Principal manages the third, also a Nifty-tracker.

It has further stated that the proposed scheme, being passively managed, would ``tend to have lower investment management fees'' compared to an actively managed one. Also, diversification of risk would be inherent in it, as the Nifty stocks have been cho sen from some 25 different economic sectors.