In this raging bull market, there are many stocks hitting new 52-week and life-time highs every day. But there is one small category of stocks that you might miss, if you don’t look closely enough: exchange traded funds (ETFs) based on equity indices. As this column is being written on 22nd August 2016, 56 new stocks hit new 52-week highs, which included equity ETFs such as Motilal Oswal M100 ETF, ICICI Prudential’s Midcap Select iWIN ETF, and Reliance Mutual Fund’s R*Shares CNX 100 ETF. Normally, an ETF hitting a new high is a non-event; but in today’s day and age where, globally, investors are moving in droves towards ETFs, this humble investment product does bear some thought.
ETF – a simple, low-cost product
An ETF tracks an index and hence differs fundamentally from any other mutual fund scheme, where the fund manager buys and sells shares based on his discretion. For example, the M100 ETF tracks the Nifty Free Float Midcap 100 index, the iWin Midcap Select ETF tracks the S&P BSE Midcap Select Index, and the R*Shares CNX100 ETF tracks the Nifty 100 Index. Hence, ETFs are ‘passive investment’ products, while mutual funds are ‘active investment’ products. Given this difference, an ETF has lower costs than an active mutual fund scheme since tracking an index does not involve the same kind of effort it does to track individual stocks and sectors. Since ETFs track indices, their returns are broadly the same. In comparison, an actively managed mutual fund scheme seeks to beat the index. To put this more simply, ETFs aren’t as sexy as stocks or active mutual funds. Distributors also have lower incentive to sell them to their clients.
However, ETFs make sense for at least three categories of people: first, provident funds and insurance companies who want low-cost exposure to equities without the volatility of active funds, second, brokers who can sell ETFs as regular products to their clients looking for simple, convenient, and liquid products, and finally retail investors who want to focus on a specific theme such as, say, the banking sector or high dividend paying stocks, without depending on (or paying for) an active fund manager.
Growing interest boosts AUMs
Equity ETFs have taken time to take-off. India’s first ETF, the Nifty Bees, was launched more than a decade ago in 2002. Awareness has picked up only recently. SBI’s Nifty 50 ETF, launched in July 2015, already has assets under management (AUM) of Rs8,020crores placing it among India’s Top 10 largest equity mutual fund schemes by AUM. This huge size helped the total AUMs of ETFs tracking the Nifty cross Rs10,000 cr in July 2016. Other than Nifty 50 ETFs, the Indian Government chose an ETF to disinvest their holdings in Central Public Sector Enterprises (CPSEs) with the CPSE ETF in March 2014. While the ETF received a positive response, its AUM stood at Rs2,136 cr as at 31st July 2016.
Mutual funds continue to rule
The NSE has many more thematic indices (based on consumption, commodities, liquidity) as well as tactical indices (based on growth, value, and dividend). Most of these do not have an underlying ETF and will probably take time before investors warm up to investing via ETFs. Till then, active fund management remains the preferred route in India. Even as the AUMs of Nifty-based ETFs crossed the Rs10,000cr mark, the overall AUMs of equity schemes is more than Rs4.5L crores. Indeed, unlike trends in the western world, active fund management is doing well in India. As CRISIL points out, its broad equity mutual fund index, the CRISIL-AMFI Equity Fund Performance Indices (CEFPI) has significantly outperformed the relevant benchmark equity indices. Since inception (1st April 1997), the CEFPI has given an annualized return of 21%, nearly twice that of the Nifty 50 (12%) and Nifty 500 (13%).
That said, choosing a mutual fund relevant to an investor’s risk/return objective remains a big decision in getting market-beating returns. Index investing, on the other hand, provides a simpler, lower risk, lower cost option.
Anupam Gupta is a Chartered Accountant and has worked in equity research since 2000, first as an analyst and now as a consultant. He contributes to the Business Standard platform, Punditry, through his blog, Beyond Markets on markets & the economic horizons.
He tweets as @b50
