ETF liquidity falls short despite breaching the Rs 1 trillion mark

Traded value has not risen at the same pace as the increase in assets under management

The value of exchange-traded funds (ETFs) changing hands on the stock market has crossed Rs 1 trillion, but surging inflows may mean investors find it harder to exit in certain situations.

The value of ETF trades has nearly trebled since 2018-19 (FY19) to Rs 1.2 trillion in 2022-23 (FY23). The value of money invested in ETFs is up nearly 4x from FY19 levels to Rs 5.1 trillion as of March 2023. 

This means it will take longer today for investors to redeem money through selling ETF units on the stock exchange than it would have taken them before the pandemic.

The traded value was 39.9 per cent of the average assets in FY19. This is down to 25.5 per cent in FY23.

Low liquidity can increase the costs for ETF investors, observes Sundeep Sikka, executive director and chief executive officer (CEO) of Nippon Life India Asset Management.

This can result in a tracking error, which is the difference between the value of the ETF and the index it tracks. There is also an impact cost.

Impact cost refers to the price changing due to large orders when liquidity is low. 

Higher impact cost affects returns. Globally, ETFs with high trading volumes and liquidity have attracted more investors, according to Sikka.

“The ETF industry globally is dominated by very few asset managers who have high liquidity. After that, there is a (long) tail,” he says.

ETFs based on stocks outside the largest blue-chip names may face some difficulty because of lower  trading activity, says Dhirendra Kumar, CEO of fund tracker Value Research.

The more liquid ETFs which invest in Nifty companies will not be as affected if the ETF was actively traded, he adds. 

Many large investors can get liquidity by unbundling ETFs into underlying securities. This option may not be available to the average retail investor. 

Eventually, more money inundating ETFs could lead to greater trading activity, with each affecting the success of the other, according to Kumar.

“It will happen with time... it is a chicken-and-egg story,” he says.

The ETF segment has grown increasingly popular because it is seen to be a low-cost alternative to actively managed mutual funds. 

Many new funds are thematic, which means they invest in stocks outside the blue-chip universe. 

The ETF segment as a whole saw Rs 1 trillion worth of inflows in FY19 and nearly Rs 57,000 crore of redemptions. The net inflow was Rs 43,351 crore.

Inflows rose to Rs 1.6 trillion in FY23 and outflows to Rs 97,000 crore. The net inflow was about Rs 59,526 crore.

The number of ETFs has risen from 78 in FY19 to 172 in FY23. The number of equity ETFs is up from 60 to 131 in the same period. Debt ETFs are up from six to 22. Gold and silver ETFs rose from 12 to 19.

The December 2022 data on ETF investors showed Rs 4.6 trillion coming from investors classified as corporates. This was over 90 per cent of the total investor capital. 

Retail investors accounted for 11.5 million accounts, or 98 per cent of total accounts.