Futures wary? Turn to ETFs

INVESTING

Want to invest in a basket of scrips which make up an index but you do not the know the nitty-gritty of futures trading?

Then you need to invest in exchange traded funds (ETFs). ETFs mirror an index since they invest in the constituents of the index in the same proportion as the index and come with the feel of the index. They are largely passive in their investment strategy and their returns are more or less in line with the returns in the index.

For instance, the Nifty Benchmark Exchange Traded Fund (Nifty BeES), floated by the Benchmark Asset Management Company, has posted returns of 74.77 per cent over the last one year as on March 26, 2004.

The Junior BeES, which tracks the Nifty Junior Index, has given a return of 153 per cent over the past one year. Over the last one year, the Sensex has returned 83.4 per cent and the NSE Nifty 81.14 per cent.

Pru-ICICI Mutual Fund's Sensex Prudential ICICI ETF (SPIcE) has given a return of 87.03 per cent over the last one year, while UTI MF's SUNDER has given a return of 67.02 per cent. Most of the index funds, during this period, have given returns in the 53-74 per cent range.

At present there are only three fund houses which have launched ETFs "" Benchmark, Prudential-ICICI Mutual Fund and UTI Mutual Fund. The corpus of Benchmark's ETF scheme is at around Rs 72 crore, Pru-ICICI's at Rs 16 crore and it is at Rs 60 crore for the UTI's scheme.

ETFs differ from other mutual funds as they are traded in units, in much the same way as a company's shares are traded.

So the market value of the units can be quoted at a price different from the net asset value (NAV). The face value of the units is pegged to the index. For instance, the price of one SPIcE unit is around one-hundredth of the Sensex.

Rajan Mehta, executive director at Benchmark, said the obvious advantages of ETFs are easy liquidity, no exit or entry loads for the investors and low expense ratio so far as the asset management is concerned.

The asset management company is only involved in minimising the tracking error between its portfolio and that of the index which it tracks. There is some discrepancy between the NAVs of the units and the market value of the units as in the case of shares.

Investors can actually arbitrage between the two. For instance, if any ETF units are trading at a discount to their NAVs, the investor can purchase the units in the market (and redeem for the actual shares at the NAV) and simultaneously selling the Sensex stocks short to realise a profit.

Of course this is theoretical but Mehta said that once the lending and borrowing mechanism comes into place on the exchanges, this can be a reality. Hedging can also be done but with the lending and borrowing mechanism in place.

Another advantage of ETFs in comparison to futures is that the trading lots are smaller than that in the case of futures where the minimum contract size is Rs one lakh, in addition to the numerous hassles of keeping track of all the margins which an investor has to pay.

Futures contracts also have the hassle of being rolled over if one takes a longer term view, increasing trading costs and tracking error.

Mehta, however, pointed out that the problem lay in making a market for such schemes and thereby improving liquidity.

At present trading is in the region of a few lakh per day for all the exchange-traded schemes.