Exchanges Traded Funds (ETFs) have been in the limelight in recent times. But this time it’s different. The recent success of CPSE ETF which has swelled its value by a whopping 43% (since its day of listing on the NSE on April 4, 2014 until May 26) compared with a modest 6% rise of the NSE Nifty index, has again brought ETFs back into focus.
There’s another reason to believe so. While in the past 6 months (between Sep 2013 to March 2014), retail folios of equity-oriented and balanced mutual funds as also gold ETFs and gilt funds dipped by -6.36%, -3.57%, -6.68% and -8.94% respectively, those of ETFs (other than gold) rose the most clocking 28.34% jump, as per the latest data by the Association of Mutual Funds in India (AMFI).
So what’s made ETFs one of the great investment stories of the past 6 months?
Choice Is Good
Investors in the equity ETFs are faced with a wide choice — there are now 23 equity ETFs (not to count gold ETFs) with an asset under management (AuM) of Rs 920 crore as on May 22, 2014. However, their number as well as the AuM is dwarfed by equity diversified funds which are around 187 in numbers holding an AuM of Rs 1,34,153 crore. Moreover, ETFs have exposure mostly to banks and benchmark indices, not to mention of gold.
One of the advantages of ETFs over other mutual funds is that unlike open-end mutual funds they can be bought and sold throughout the trading day like any stock. ETFs, as the name suggests, are baskets of stocks that passively tracks an index like an index fund, but are traded like individual stocks on an exchange. By providing exposure to an index or a basket of stocks, ETFs allow long-term investors to diversify their portfolio at one shot.
More importantly, ETF is one unique asset class that is suitable for all types of investors, whether retail or institutional, long-term or short-term investors, and even arbitrageurs in one way or the other. The fact that ETFs are liquid enough distinguished it further with other asset class. ETFs closely track the performance of an index throughout the day giving investors the ability to buy/sell at any time.
“ETFs are the most cost-effective routes to track the index of an asset class. There are three key benefits that ETFs offer to investors (a) lower management cost than normal mutual funds (b) real time market pricing vis-a-vis end of the day NAV in mutual funds and (c) high tracking co-relation with underlying asset class,” maintains Manoj Nagpal, CEO, Outlook Asia Capital.
Although ETFs are like any other index fund, they offer a number of advantages over traditional open-ended index funds. One is that they have lower expenses ratio than index mutual funds and traditional mutual funds. The annual expense ratio of ETFs generally varies from 0.05% to 1.60%. One of the reasons why ETFs entail low cost is because of their lower management fees and lesser cost of distribution since they are listed on an exchange. However, since trading in ETFs involves paying brokerage (because they are bought as stocks through a broker), the cost could escalate if you trade frequently.
“A diversified equity fund has a single charge structure which is built into the NAV whereas owning an ETF leads to multiple charges of ETF fund management, transaction cost and custody charges,” adds Nagpal. This means for a retail investor this multiple charge structure of an ETF may lead to an overall higher cost and difficulty in assessing the net returns. The Second advantage is the convenience of redemption. While redemptions of index funds happens at a fixed NAV price, ETFs give the flexibility of buy and sale on the exchange throughout the day, to take advantage of the prevailing price, which is closer to the actual NAV of the scheme at a given point of time. Further, in contrast to closed-ended funds that trade at substantial premia or at discounts to their NAV, ETFs are traded near their actual NAVs (See Peer Comparison..). This gives ETFs a distinctive advantage in the sense that it substantially reduces the risk of mispricing or price differences between the time of investment and time of trade. This reduces the tracking error of ETFs compared to traditional index funds.
So, if you’re looking to gain exposure to the equity markets as well as have the flexibility to buy and sell units of ETFs throughout the trading day, ETFs could be an option to explore.