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For the passive investor

Dipta Joshi  |  Mumbai 

Taking the ETF or index fund route makes sense. But there are costs involved for opening a demat account and trading through a broker.

Thirty nine-year-old Sanjay Jadhav has been contemplating investing in the equity markets for sometime now. But he is unsure how to go about it. One, he lacks the expertise for stock-picking. Two, he does not want to track stocks prices or mutual fund net asset values on a regular basis.

For someone like Jadhav, Hemant Rustagi, CEO, Wiseinvest Advisors, advises exchange-traded funds (ETFs) and index mutual funds. Both track the broader benchmark indices and deliver returns that closely match their performance. The fund manager has a limited role to ensure that the selected stocks work as efficiently as the index these mirror.
 

HOW THEY STACK UP
Average returns *
Index ETFs  1 year  6 months
S&P CNX Nifty UTI ETF (NSE) 28.75 -0.99
Hangseng Bees (NSE) 11.58 4.47
Quantum Index Fund-ETF (NSE) 11.04 -4.96
Nifty Benchmark ETF (NSE) 10.96 -3.89
Kotak Nifty ETF (NSE) 9.88 -4.07
Nifty Jr Benchmark ETF (NSE) 4.02 -13.00
Hangseng Bees (BSE) 15.08 14.47
Kotak Nifty ETF (BSE) 11.65 -2.94
Kotak Sensex ETF (BSE) 11.17 -1.98
Nifty Benchmark ETF (BSE) 10.90 -3.72
UTI Sunder ETF (BSE) 15.55 -8.56
* As on 8th April '11 (% p.a)
 
Index mutual funds 1 year 6 months
Equity large cap 9.99 -4.88
Equity mid & small cap 5.76 -11.07
Equity multi cap 8.60 -7.80
Equity large & mid cap 8.25 -6.77
Benchmark indices  1 year 6 months
Sensex 9.81 -3.94
S&P CNX Nifty 10.13 -4.28
BSE midcap 2.17 -13.89
BSE small cap -1.98 -16.55

Among the two, ETFs stand a better chance of beating the index because of their lower tracking errors. Over the last one year, index ETFs have outperformed both the Sensex and Nifty. Index ETFs have given an average of 11 per cent as compared to the Sensex’s 9.81 per cent returns. During the same time, ETFs tracking Nifty returned around 10.39 per cent while S&P CNX Nifty’s returns were pegged at 10.13 per cent. Also, equity largecap funds gave 9.9 per cent returns.

“Investors, who would like to diversify within this asset class itself, could look at sectors funds or ETFs. “However, these will always carry the risks associated with the sector,” warns Rustagi.

Those with long-term outlook could include gold ETFs to balance their portfolio, says Hiren Dhakan, associate fund manager, Bonanza Portfolio. “Once you are already invested in equity, investing five-seven per cent of your portfolio across a different asset class could be looked at,” adds Dhakan. Gold ETFs have given over 20 per cent returns during the last year.

For those planning to diversify globally, Dhakan’s advice is to stay away from markets that are similar to the Indian markets. So, one could avoid other emerging markets indices such as the Hang Seng Benchmark ETF, and opt for the ETFs tracking other developed markets like the Nasdaq. Of course, one must not forget the exchange rate risk involved in investing in global funds.

COSTS INVOLVED

Both index funds and ETFs have lower costs as compared to active mutual funds, since these do not spend on research and other operating costs. While an active mutual fund will charge 2.25 per cent annually, management fees for an index fund is 1.5 per cent and for an ETF will be one per cent.

However, unlike index funds, which can be bought and sold from fund companies, ETFs are traded on exchanges through a broker. So, one needs a demat account to buy and sell ETFs.

It means one would be paying brokerage and demat maintenance charges, in addition to the ETF management fees. In case of selling unit of the index fund before a year, there would be an exit load of one per cent.

TAX ON TRANSACTION
Both ETFs and index funds get the same tax treatment as the other equity mutual funds. So, while the Securities Transaction Tax applies to both, there is no long-term capital gains tax on these. The short-term capital gains tax is 15 per cent.

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First Published: Tue, April 12 2011. 00:33 IST
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