ETFs triple in 2 yrs on back of steady inflow from EPFO, provident funds

The assets of exchange-traded funds (ETFs) have nearly tripled in the past two years, on the back of steady inflow from the Employees Provident Fund Organisation (EPFO) and provident funds.

ETFs are traded on stock exchanges, with stocks, bonds or commodities as the underlying product. An ETF’s portfolio exactly mimics the securities in its underlying index, in the same weightage.

The EPFO had entered the stock market in August 2015. The decision was to invest up to 5 per cent of its investible deposits; this was raised to 10 per cent in 2016 and then to 15 per cent in 2017.

ETF schemes run by SBI Mutual Fund (MF) and UTI MF have cornered most of the EPFO inflow, with the former getting three-fourth of the amount, estimates suggest. SBI Nifty ETF, for instance, currently has assets of over Rs 55,000 crore.

While delivering his speech as the chief guest at Business Standard Fund Café 2018, UK Sinha, former chairman of the Securities and Exchange Board of India (Sebi), said globally trillions of dollars were moving from active funds to passive funds, and the same trend could play out in India.

“Even when the EPFO started investing in the markets, it preferred index funds, not active schemes… very serious focus on cost reduction is required, without which the industry may face some serious bumps,” Sinha said last week.

Kaustubh Belapurkar, director-fund research at Morningstar Investment Adviser India admits that the absolute alpha generated by categories such as large cap schemes has declined and it has become increasingly harder for fund managers to beat the market because of the acute polarization in stocks seen since 2018. That said, he believes that active fund management still holds an edge in generating long-term alpha.

One reason passive funds have stolen a march over their active peers in developed markets is the sheer size of MF assets, observed Belapurkar. In the US, for instance, MF holdings comprise about a third of the overall market size. India’s equity mutual funds, on the other hand, still hold less than 8 per cent of the overall market assets.

At present, only about 5 per cent of ETF assets is held by retail investors. That may change as liquidity improves in the ETF space and participation from cost-conscious institutional investors sees a surge. Expenses for active funds range from 1-2.25 per cent but that for ETFs can be as low as 10-15 basis points.  

  
ETFs may get a fillip this year from the government’s stake sale plans. The Union Budget has hinted that the ETF route may be used more aggressively to meet this year’s Rs 1-trillion-plus disinvestment target. The government has proposed tax exemptions to exchange traded funds (ETFs) that have central public sector enterprises (CPSEs) as the underlying. These ETFs will get the status of equity-linked savings schemes (ELSS).

The proceeds from the Centre’s existing ETFs, the central public sector enterprise (CPSE) ETF and Bharat 22 ETF, accounted for about 53 per cent of the Rs 84,972 crore that DIPAM earned in 2018-19.

In the past couple of years, ETFs have benefited from regulatory changes. Returns of equity schemes are now benchmarked against a total returns index (TRI) instead of a simple price return index. This has impacted the overall alpha for equity schemes, especially for large-cap funds. The TRI assumes that any cash distributions, such as dividends, are reinvested back into the index.

The regulator has also tightened the definition of what constitutes a large-cap, mid-cap, small-cap and multi-cap funds. This means fund manager are no longer be able to change styles, known in sector parlance as “style drift”. All this has somewhat reduced the attractiveness of actively managed large-cap funds and pushed investors towards passive products such as ETFs.