Recipe for market success: ETFs, the secret sauce stirred into growth

Now a dominant ingredient, with holdings topping 10% of the free-float mcap

Exchange-traded funds (ETFs) have played a crucial role in driving the nearly 80 per cent gain recorded by domestic markets since 2021. They are also emerging as dominant investors, with their holdings now exceeding a tenth of the total free-float market capitalisation (mcap).

“As a testament to their growing influence, passive flows have been major contributors to the market rally observed over the past few years. Since 2021, domestic ETFs have channelled net inflows of $52 billion into domestic stocks,” says Sriram Velayudhan, senior vice-president at IIFL Securities.

The combined holdings of domestic and overseas ETFs in the National Stock Exchange Nifty 50 stocks amount to $155 billion, representing 12 per cent of their free-float mcap and 14 per cent of institutional holdings in these companies.

ETFs — designed to mirror the returns of their underlying benchmark indices, such as the Nifty, S&P BSE Sensex, or MSCI Emerging Markets — have seen their popularity rise over the past decade.

Low costs, the underperformance of actively managed funds, and ease of investment have further burnished their appeal.

The holdings of ETFs — both domestic and overseas — now account for 5.2 per cent of India’s mcap, up from just 1.8 per cent in 2015, according to IIFL Alternative Research.

Since 2015, the holdings of overseas ETFs managed by MSCI and FTSE have increased fivefold, from $26 billion to $130 billion. During this period, the ownership of these ETFs in domestic companies has grown from 1.7 per cent to 2.7 per cent of their total mcap.

In contrast, the ownership of actively managed foreign portfolio investors has decreased from 18 per cent to 15.4 per cent.

Domestic ETFs have experienced an even greater leap, with their assets under management surging sixty-eightfold, from just $1.8 billion in 2015 to $123 billion currently.