Stock markets in India have been volatile with a downward bias since the beginning of this calendar year. In such market conditions, investors are often confused whether to put fresh money in equity funds or wait for further correction. The confusion is further accentuated when one realises that there would be fund management cost of 2-2.25 per cent, depending on the size of the scheme.
In such cases, investors, looking to put money in equities, could look at cheaper forms of investing. ETFs, or exchange traded funds, are one such option. Says a financial planner, “ETFs are the least volatile vehicle to take equity exposure. In addition, they are cheaper too.”
ETFs try to replicate a designated benchmark index. So, they invest in the same stocks and in the same weight as in the index.
Currently, there are ETFs that follow broad-based benchmarks such as the BSE Sensitive Index, or Sensex, S&P Nifty and S&P CNX 500. Fund houses also offer sector-specific ETFs such as banking (Bankex). Also, there are commodity ETFs as well, like gold and silver.
According to experts, these funds are meant for investors, who do not want to churn their portfolios often. “I would recommend passive investors to take this route,” says Hemant Rustagi, CEO, Wiseinvest Advisors.
Also, investing in such funds ensures that one do not have to track the portfolio regularly. “Since the net asset value (NAV) of the scheme will be based on index stocks or commodity prices, it is quite easy to follow them. In case of diversified equity funds, one would need to look at the portfolio for the fund manager’s picks,” added the financial planner.
The annual fund management fee for equity ETFs is as low as 1-1.50 per cent. Of course, proponents of diversified equity funds say that in India, fund managers can get better returns as there is enough scope for them to pick good mid-and small-cap stocks. However, in efficient markets like the US, it has been observed that actively-managed funds get little scope to beat the benchmark.
“But investment in ETFs need to be just like mutual funds through systematic investment plans,” opines Rajan Mehta, director, Benchmark Mutual Fund.
The manner in which ETFs traded is also an advantage over other mutual funds. As ETFs, like shares, can be traded online, investors can take the advantage of market condition, and can buy on lows and sell on highs. In case of MF schemes, it takes a day for application to be processed and fund house to take appropriate positions.
However, ETFs have numbers of shortcomings. On numerous occasions, ETFs give lower or higher returns compared to the benchmark return. This variation is called tracking error. It occurs when a fund house keeps higher cash due to fear of redemption. It can also happen when the stocks or weight in underlying index changes and a fund house lags. Ideally, the tracking error should be 0.5 per cent.
Also, there are times when a fund manager actively manages the portfolio by investing in derivatives. Such funds need to be avoided as derivative calls can go wrong, impacting the scheme’s performance. So, experts usually advise to go for a fund that has the lowest tracking error.
Any investor who wants to deal with ETFs, requires a trading and demat account. Consequently, they are not as popular with investors as other MF schemes. So, if you are investing for the first time in equity or do not want to worry about your fund’s performance consistently, invest through ETFs.
