Exchange-traded funds are rapidly rising in popularity charts. But do they make good investment sense? Read on...
PARAG Kar invests regularly in exchange-traded funds (ETFs). He is comfortable investing in them because of their simplicity and low costs. He has started SIPs (systematic investment plans) in Nifty ETF and gold ETF. "It gives me the option to invest over a long period without bothering about market conditions. Chennai-based SG Chellappa, who recently retired and manages his family's portfolio, started investing in gold ETFs a year ago. It is difficult to store physical gold and there is no guarantee of purity, hence, I find ETFs a better way to invest.
And if fund managers are to be believed, the trend is indeed catching up. ETFs have recorded a growth of 65% in their AUM during the past one year. The first ETF was launched by Benchmark in 2002 and since then they have come a long way. Today, ETFs manage 4,787 crore, compared with 3,000 crore in April 2008. While gold is the most popular ETF traded, there are several ETFs such as Bank ETF, and Nifty ETF which are catching investor's fancy. So, what is driving investors towards ETFs?
Popularity Ratings...:
In India, investors have just started warming up to ETFs in the past couple of years. The rising price of gold has played a major role in increasing the popularity of gold ETFs. In fact, this is why gold has become the most popular ETF option for investors. As prices continue to rise without a breather, investors have realised that holding gold in its paper avatar is not only convenient but is also a more cost-effective way of owning the precious metal. Besides Benchmark Mutual Fund, there are several other asset management companies such as Quantum, Kotak, HDFC, ICICI Prudential that offer gold funds.
With a small amount of 2,000, you can buy a gram of gold. There is no storage problem nor is there a doubt about purity, so this is the best method to invest in the yellow metal.
In addition, there are ETFs based on Nifty, Bank Index, Infra Index that are also gaining popularity. In the US, six out of the 10 top traded counters are ETFs. Demand for ETFs is increasing and there are several more ETFs which are likely to be launched during the next one year.
Benchmark has already filed documents with the regulator and is waiting approval for ETFs on energy and pharma. On the fixed income side, the fund house has filed for Gilt ETF. Motilal Oswal AMC, which runs the M50ETF, has filed for a midcap ETF with the regulator. M50 found favour with investors since it gives weightage to stocks based on their valuations and performance rather than market capitalisation.
…And The Advantages:
There are several advantages of investing through ETFs. First is the reach. Exchange terminals are located across the country. You can buy the units on a real-time basis when the stock markets are open. With NSE terminal location across the nook and corner of the country, it is very easy to reach investors.
ETFs provide investors with a fund that closely tracks the performance of an index throughout the day with the ability to buy/sell at any time, making it easier to utilise opportunities that arise during the day. Compared to open-ended funds, NAVs of ETFs are fixed only once during the day. ETFs score on the cost factor also. While the expense ratio of actively-managed mutual funds can vary from 1% to as high as 2.5% in the case of ETFs, the expense ratio is much lower.
For example, Benchmark Gold ETF has an expense ratio of 1%, while Nifty Bees expense ratio is only 0.5% annualised. Since an ETF is listed on an exchange, the cost of distribution is much lower and the reach is wider. These cost savings are passed on to the investors in the form of lower costs. Further, the structure helps reduce collection, disbursement and other processing charges. It is also possible to do a SIP in ETFs. However the broker with whom you deal has to provide that facility. Several brokerages such as HDFC Securities, Sharekhan and ICICIdirect offer this facility to investors.
Tracking error, which is the divergence between an ETF's NAV and the underlying index, is generally observed to be low as compared to a normal index fund due to lower expenses and the unique in-kind creation/redemption process.
However, before you invest, you should keep in mind the fact that some of the ETFs may be illiquid in nature, resulting in a higher bid-ask spread. Secondly, since you are transacting through a broker, you need to take those transaction costs into consideration.
So Should You Go For ETFs?:
According to the S&P Crisil SPIVA report for June 2010: Over a five-year period, a majority of equity funds underperformed the benchmark index. Most notably, 64% of the large-cap funds underperformed the S&P CNX Nifty over the study period. Over a shorter time frame (1 year and 3 years) though, a bulk of the equity-oriented funds outperformed their respective benchmark indices. Despite this, most financial planners recommend diversified funds. In developed countries where markets are mature and where institutional players are large, there is little scope of finding sectors and companies. However, in India, which is fast-evolving, the market is yet to mature. Here, there is a significant opportunity for diversified equity funds to outperform ETFs. However, he recommends ETFs as the way forward in commodities and recommends gold ETFs to investors. Echoing a similar view is Ranjit Dani, a Nagpur-based financial planner. There are enough opportunities for a fund manager in India to create alpha. Besides this, he feels that stock brokers do not have the temperament to sell mutual funds and very few of them encourage long-term investments in ETFs. Stock brokers have a short-term mentality, while a mutual fund is a long-term investment. Since ETFs are only available through stock brokers, they have been slow starters in India.
While we do recommend ETFs, we feel investors should have a mix of equity funds and ETFs in their portfolio, founder and director, fundsindia.com. So, while ETFs do have some merit in your portfolio, it will be tough to pack your entire portfolio with them. You could have a mix of diversified funds and some ETFs to fulfil your portfolio needs.
