Here's why ETFs are doing better than actively managed large-cap funds

Why are exchange-traded funds (ETFs) doing better than actively managed large-cap funds these days? Will this trend continue?

In recent times, the Indian markets have seen a concentrated rally, that is, a rally in select stocks has­ contributed to the overall market rally. As large-cap funds are actively managed funds and have a broader universe than the Nifty 50 or the S&P BSE Sensex, these funds may or may not have these select stocks. This has been the primary reason for actively managed funds underperforming vis-a-vis exchange-traded funds, which track these market indices. These market anomalies are not sustainable for the long term. The Indian markets have not yet reached the level of efficiency where there is no room for alpha generation, provided by actively managed funds.

What are value-oriented funds and where do they invest? What kind of investors should invest in these funds?

Value-oriented funds invest in stocks of companies that are under-priced as compared to their fundamental value. These funds try to invest in companies where the fund manager believes that the intrinsic value of the company is more than its current market value. Investors who are looking at higher margin of safety while staying invested for the long term may consider investing in these funds.

In the international mutual funds space, does it make sense to focus on the US market, or should one invest in a fund that diversifies across different regions?

Investors who have significant exposure to Indian markets can look at international funds for geographical diversification and also to benefit from currency depreciation. Exposure to different markets should be based on one’s risk appetite and after a proper understanding of the economic conditions of the different geographies. Investors should consult their financial advisor to understand the level of exposure and the geography which they should invest in, based on their risk level, financial goals, and current mix of funds in their portfolio.

How important is fund size when evaluating a scheme?

Fund size should not be looked at in isolation. It should be examined in line with the investment universe of the fund. For example, a small-cap fund can face liquidity concerns with rise in assets under management (AUM), since the market cap of this investment universe is small. On the other hand, a large-cap fund can manage higher AUM with ease. Thus, the fund size of a scheme should be evaluated in alignment with the investment mandate, and there cannot be a single level of fund size that can be defined for all funds.

Can you explain the recent changes the Securities and Exchange Board of India (Sebi) has made to the total expense ratio and how it will impact investors?

To pass on the benefits of economies of scale to investors, Sebi has revised the scheme expense ratio for all mutual fund schemes. According to the Sebi circular, the scheme expense limits have been revised downward for different levels of AUM.

If I want to invest in ETFs, do I need to have a trading account along with a demat account compulsorily? Is it possible to buy ETFs without a trading account?

Yes, you need to have both a trading account and a demat account to invest in ETFs. Investing in ETFs is similar to buying and selling shares on exchanges through your trading account. You can place a buy/sell order with the broker that you hold a trading and demat account with, through either the online terminal or by placing an order through telephonic mode. Also, the units purchased/sold have to be bought in whole number of units, for example, 10 units of an ETF.

The writer is MD & CEO, SBI Mutual Fund. The views expressed are the expert’s own. Send your queries to yourmoney@bsmail.in