Introduction/Definition of ETF/ A Brief Primer on ETF’s
Exchange Traded Funds or ETF’S are like mutual funds which are traded in secondary stock
market just likes shares of Reliance, HDFC etc and are indirect way of investing in stock
market.
ETF’s try to replicate the underlying index(say Nifty 50) by building a portfolio that has
exactly same no. of stocks & also in the same proportions as underlying index( Here 50
stocks in weightage based on Market Capitalization).
ETF’s = Best of characteristics of (Mutual Fund + Stocks)
Passive V/s Active Investing Style
Nifty 50/S&P 500 are usually used as a benchmark for performance evaluation. So fund
managers who try to beat the benchmark are termed as Active Fund Manager & said to have
active style of investing whereas one’s who try to meet the benchmark are passive fund
managers & are said to have passive style of investing.
For E.g. Nifty’s return for 2019 was around 12% so a manager who through his cognitive
intelligence & analyzing skills claims to generate a return exceeding 12% would be active
fund manager, whereas one who through replicating constituents of Nifty would aim at
generating a 12% return as was provided by Nifty would be a passive fund manager.
Active Investing style has more transactions cost/brokerage involved on account on rapid
turnover/churning of stocks in their portfolio in order to generate excess return than
benchmark (called as Alpha), high cost on account of high investment manager fees etc
ETF’s are passive investing style as they replicate an underlying index (which is generally the
benchmark) thus trying to meet the benchmark & not trying to beat the benchmark.
Differentiating ETF’s with Mutual Fund & Index Funds
All of the above triplet have a lot in common, yet there are key differences in the way they
are managed. Index Funds are more synonymous to a mutual fund but unlike mutual fund
which invest in various corporate’s securities & stocks, Index Fund aim to track an index
(Say DJIA, S&P 500 etc).
ETF’s are passively managed & can be bought & sold at any time on a single click of a
button, whereas Mutual Funds (which are actively managed) & Index Funds (which are
passively managed) can only be purchased at end of each trading day at a certain price called
as Net Asset Value (NAV).
Reasons for growing popularity of ETF’s
Some of the prominent reasons responsible for increased popularity of ETF’s are as follows:-
1. Diversification Benefit :- It is a common saying that “Don’t put your eggs in one
basket” – which simply means diversify & invest in multiple rather than just a single
stock in order to minimize the risk associated & ETF’s best serve the purpose here.
2. Tax Efficiency :- Involve fewer taxable events on account of fewer turnover or
churning of portfolio, no securities transaction tax (STT) levied.
3. Active Secondary Market :- Improved liquidity through real time trading’s, does
provide an advantage as compared with a mutual fund.
4. Minimal Cost for Investor :- They have a low expense ratios due to negligible
management fees, brokerage fees & transaction cost as they are passively managed.
History of ETF’s Industry in India
Nifty BeEs - First Liquid BeEs - First Gold BeEs - A
Bharat 22 ETF
Indian ETF Fixed Income ETF Gold ETF
(2017)
(2001) (2004) (2007)
Global ETF Market Perspective
Since it’s launch the global ETF market has experienced tremendous growth, with around
7800 ETF’s product globally available & USD 5.37 Trillion Assets under Management.
Growth of ETF Market in India
Assets under management represents the total market value of investments that a firm
manages on behalf of their clients.
The following graph represents 2 fold increase in Assets under management of Indian Mutual
Fund Industry in a span of 5 yrs. from 2015-2020. Industry AUM stood at INR 28.23 Trillion
as on 31st October, 2020.
Assets Under Management Of Mutual Fund Industry In
India
30
25
AUM (in Trillions)
20
15
10
0
2015 2016 2017 2018 2019 2020
Years
The following graph represents a 54.6% increase in ETF’s Assets under management as
compared to previous year. ETF’s AUM stood at INR 2.19 Trillion as on 31st September,
2020.
ETF's Assets Under Management
250,000
200,000
AUM (in Crores)
150,000
100,000
50,000
0
2015 2016 2017 2018 2019 2020
Years
The following graph represents an increasing contribution of ETF’s AUM to Total Mutual
Fund AUM in India representing growing popularity of the ETF’s among retail masses &
Institutional investors. ETF’s contribution to total AUM in India has risen from merely
1.26% in 2015 to a significant 7.72% currently.
Contribution of ETF's AUM to Total Mutual Funds
AUM in India
35
30
AUM ( in Trillion)
25
20
15
10
5
0
2015 2016 2017 2018 2019 2020
ETF's AUM (in Trillion) Years
Mutual Fund AUM (in Trillion)
Key Bottlenecks to ETF’s adoption in India
1. Lack of developed marketing or distribution channel:- Mutual Funds sell their
products to people through distributors who are paid certain amt of commission for
the same. However in case of ETF’s to keep the cost low, there’s no commission &
thus it provides no incentives for distributors to recommend ETF’s over hefty
commission paying mutual fund products to the general public.
2. Lacks diversity or variety:- More than 85% of ETF’s in India are large cap Equity
based, however Investors prefer options both within equity ETF’s (Small cap, value &
Growth ETF’s) as well among other various asset classes (like Fixed Income,
Currency etc.)
How to increase public participation in ETF’s
Conclusion: The Future ahead for ETF’s
Indian investors though can’t have a control over return but definitely can ensure that their
investing costs are kept minimal. An ideal investor need an instrument that provides high
liquidity coupled with reliable returns, which is in fact best served by ETF’s.
I personally do believe that ETF has started making inroads to investors portfolio and is on
the course to become a huge market offering option for varied types of investors. It’s no
doubt that ETF’s are cost-efficient & environmental friendly in contrast to traditional mutual
funds.
As the market evolves with government & SEBI coming into picture to strive to increase the
awareness of ETF’s, Indian markets are bound to see a diversity of new ETF’s being
launched & existing one’s undergoing rapid financial innovations. This subsequent growth of
ETF’s would prompt a slow & steady but a significant drop in cost associated with mutual
funds as a pooled investment vehicle used by general masses, thus creating a better landscape
for the investors.
As an investor or an analyst, the next time to plan to make an investment or analyze a
portfolio do consider ETF as an viable option & consider your options well before investing.
Happy Investing!
