ETF as an Investment

ETF as an Investment

ETFs has been in the financially world only since the past 25 years, however it has
captured the likes of institutional and retail investors round the world. In the beginning,
they were promoted as an inexpensive, index-investing option vis-à-vis mutual funds.
Index investment itself is a concept created by John Bogle, the founding father of
Vanguard Group that is one of the largest AUM’s in the world with over $6 trillion in
Assets underneath Management.

So what is an ETF and how did they gain popularity in India?

ETFs are funds that track Indices. Hence when once buys units or shares of an ETF, you
are purchasing units or shares of a fund that tracks the yield and return of its native
index. ETFs do not try to outperform or beat the index instead they mimic the index
Unlike other funds, ETFs trade like any other stock on the exchanges hence their price
fluctuate throughout the day.

In India, just like the US, ETFs have gained popularity because the top hedge funds or
top AMCs have failed to beat the market benchmark in the past 5 years as per studies.
Hence, a “Passive ETFs” is a better bet for investors.
Along with this advantage, ETFs are also cost effect. Typical ETF administrative costs
are around or less than 0.2% annually as compared to actively managed funds that
charge up to 1% fees.

How do ETFs work?

As mentioned earlier, the ETFs are traded on the exchanges like other stocks. They act
like both shares and mutual funds.

The price of an ETF depends on the cost of the underlying asset itself. Hence, if the
asset’s price goes lower or higher the price of the ETF reacts in direct proportion.

ETFs are managed both actively and passively. Actively managed ETFs are handled by
portfolio managers who try to mitigate the risks and understand the market conditions.
While Passively managed ETS follow a certain Indices trend

Even though these ETFs come with cost advantage there are certain limitations that
come with it such as

Brokerage fees : One can either for a fund manager to handle their funds or manage
the funds by the themselves by opening a Demat account. If a fund manager is
appointed then the investor may incur some commission fee costs.

Market Volatility : ETFs heavily depend on the market trends. Hence, in good times the
investor may earn handsome profits while in bad market conditions the investor may also
incur heavy loses.

Diversification : As per study, most ETFs are passively handled hence majority the
stocks chosen for investment would be best performing stocks, often the bluechip stocks
whereby ignoring the potential of small cap companies.

Types of ETFs available :

Equity ETFs : These funds have investments in equity instruments, 

Gold ETFs : Such funds deal in commodity exchanges. These fund include physical gold
assets. Purchasing units and shares of these funds makes an investor owner of gold on

Debt ETFs : These funds comprise of debt securities such as debentures, commercial
papers, government securities, etc.

Currency ETFs : These funds purchase currency of different countries and gain profits
from the currency fluctuations. These funds are based on future performance of the
currency which is predicted with specific calculations.

ETF Performance in India

Total ETF asset under management stands at Rs 2.07 lakh crore as of August 2020, and
Nifty50 focused ETFs made nearly fifty perfect of the whole lot. The value of AUM in
Nifty50 ETFs is now at it’s record high, Rs. 1.02 lakh crore.

According AMFI data it was observed that the domestic ETF AUM linked to equity and
debt had grown at a rate of 65 per cent per annum over last 10 years. ETF AUM has
increased by more than Rs 60,000 crore this financial year despite disruption caused by
the pandemic. One of the reasons behind this success rate could the market creating
new highs and giving investors their gains.

Almost 17 asset management companies introduced ETF schemes based on Nifty50 till
now, and they command 49 per cent market share. While there are 11 ETFs linked to
Nifty50 outside India with investments worth around a billion dollars.

There are nine products with focus on BSE Sensex, with AUM at Rs 41,276 crore,
according to a BSE spokesperson. The AUM of Sensex ETF grew 50 per cent from Rs
27,556 crore in March 2020.

According to the Icra data, NSE Indices have a 77 per cent market share of ETF market,
while BSE indices, holds 22 per cent. In the debt ETF segment, NSE indices enjoy a
virtual monopoly, thanks to Bharat Bond ETFs that have got huge inflows.
Yet, penetration of ETFs among retail investors still remains low. For example, 88 per
cent of equity fund AUM is contributed by individual investors (retail + HNI), but in the
case of ETFs, it is only 8 per cent. Moreover, just 1 per cent of retail mutual fund
investors’ money is in ETFs.