ETFs: small but picking up

Even as India’s first Exchange-traded fund (ETF) was launched in 2001, ETFs as a category hasn’t been able to corner a sizeable share of the assets managed by the mutual fund industry. Assets under ETFs currently account for a little more than one per cent of the fund industry's total net assets. As on 31 July, India had 31 ETF products in its kitty with total assets under management at Rs 8,513 crore. On top of it, it's only Gold ETFs which have caught the fancy of investors. While a third of them are Gold ETFs, the assets under Gold ETFs comprises close to three-fourth (or Rs 6,119 crore) of the assets under the ETFs category. Out of close to 47 million investors' folios which the mutual fund industry currently commands, ETFs contribute only half-a-million folios.

Industry experts say that Indian investors are not yet aware of the benefits of ETFs and education regarding the same holds key to the development of the market. There are other fundamental reasons, too, which suggest that the rise of the ETF category is more likely to be gradual, even as they are more cost efficient.

What are ETFs?
An ETF is a passively managed mutual fund which is traded on a stock exchange. It is a collection of stocks or bonds and is traded like any other stock during market hours. They are similar to index funds in the construction of their portfolios. Unlike the typical mutual funds, ETFs have low expense ratios and are less risky than individual stocks. The only costs, which investors have to bear is the stock transactions fees (brokerage and demat) at the time of buying and selling.

In a normal mutual fund, investors buy units from the fund house and when they want to redeem, held units are sold back to the fund as assets are held in a pooled account of investors. In case of ETFs, investors buy and sell to other investors as if they are buying and selling stock. Moreover, an ETF does not have the same kind of risk which an individual stock will have because it is a collection of stocks. For instance, if an investor is invested in ETF based on the CNX Nifty, which consists of 50 large-cap stocks, impact on his portfolio will be very little even if some of the individual stocks crash. It will be limited to the weight of that stock in the Nifty.

ETFs are the future?
Although ETFs haven’t yet made a significant mark in the Indian markets, experts believe that the category will only grow bigger with time.

David Abner, director of Institutional ETF Sales and Trading at Wisdom Tree Asset Management, says, “Based on all the dynamics of this country and its investors, I think it is important to educate various market participants and bring products in India. One will soon realise the growth. Compared to the products which existed before, ETFs offer real benefits to investors.” Agrees Rajan Mehta, a seasoned fund manager: ETF as an instrument for investment is going to be the future in India. According to him, the ETF market is set to grow as the product has remarkable characteristics and is simple with lower costs attached.

Another factor responsible for ETFs not gaining popularity, experts suggest, is that Indian fund managers with a good track record typically manage to outperform broader markets (indices) by a margin of 5-15 per cent. This could be the reason why investors are still willing to take the additional risk (and pay higher costs) for the additional return. However, they add, as the Indian markets mature, it may become difficult for fund managers to deliver alpha (excess return over its benchmark), and consequently tilt the balance in the favour of ETFs.

Notably, in the recent past, a large part of the foreign inflows into India have come through the ETF route. While it is anybody’s guess how soon ETFs will become popular with the Indian investor, their benefits are clearly known.

Abner rightly puts it. “Mutual funds are like black & white televisions and an ETF is like a plasma TV which offers all the benefits along with the current modern efficiencies.”