Everything You Need To Know About ETF Investing

There is a tectonic shift happening in the asset management industry, all over the world. Passive investment is attracting more and more funds compared to active funds. In one of the reports by Emerging Portfolio Fund Research (EPFR), a company that provides fund flows and asset allocation data, between 2007 and 2018, the Asset under Management (AUM) of passive funds has increased from USD 700 billion in the year 2007 to USD 3.9 trillion in 2018, showing an annual growth of 19 per cent. One of the reasons for such a rise in the passively managed funds is their performance. In a 10-year period in USA market, 89 per cent of the actively managed funds underperformed the passive funds. In case of mid-cap and small-cap dedicated funds, almost 93 per cent actively managed funds underperformed passively managed funds.





India is also catching up fast with the international trend and the reason remains the same-difference in returns. According to Refinitiv Lipper data, India’s passive funds have delivered an average return of 9.6 per cent so far this year, much higher than active funds’ 5.7 per cent. In 2018, passive funds posted 2.3 per cent gains, while active funds had negative returns. In terms of per cent, actively managed funds that underperformed passive benchmarks have increased in recent years.



AUM Trends
The return difference has attracted investors in Exchange- Traded Fund (ETF). The latest monthly data released by the industry body-Association of Mutual Funds in India (AMFI) for the month of December 2019 shows that the total net inflow in the other ETF was at Rs 12,673 crore. If we look at the AUM trend of other ETFs (that includes ETFs other than gold ETFs) then, it is on a rising trend. Whereas, in case of gold ETFs, they have witnessed a severe fall from the start of the period of the study. However, from March 2019, it has again started to move up. If we look at the 5-year AUM growth then, on an average, the AUM of other ETFs grew at 90.64 per cent per annum and gold ETFs showed a negative growth of 4.46 per cent per annum. The AUM trend of other ETFs clearly shows the interest of investors is indeed growing towards the ETFs.



What are ETFs?
Despite such a rise in the ETFs investment, very few investors know and understand about ETF. This instrument is fairly new to the investor community. In our special report, we would touch upon all the aspects of ETFs to help you understand in making a right investment choice.

Let’s start with the basics-by understanding what ETFs are. An ETF is an investment avenue that is a portfolio of securities such as stocks that often track their respective underlying index. ETFs in many ways are like mutual funds. However, the only difference is that, ETFs are listed on exchanges and they are traded throughout the day just like any other ordinary stock. Some of the examples are-Nifty ETFs, Sensex ETF, etc which tracks the Nifty 50 index and Sensex index, respectively. ETFs by virtue can invest in stocks, commodities, bonds or their mixture.

Equity ETFs
Equity ETFs are the most common type of ETFs that are traded on exchanges. They invest in equities domestically or internationally. Currently, there are around 65 equity ETFs available for investments. Most of the equity ETFs is from the fund houses, such as Nippon India and ICICI Prudential AMC (Asset Management Company).

In terms of AUM, however, SBI - ETF Nifty 50 is on the top with AUM of Rs 65,000 crore as on November 2019. When it comes to ETF that has generated the best returns, it is Motilal Oswal Nasdaq 100 ETF that delivered the highest returns (46.72 per cent) among other equity ETFs.

Debt ETFs
Debt ETFs are those that invest in short-term, medium-term and long-term debt instruments. Presently, there are only six debt ETFs that are available for trading on exchanges, out of which, three are liquid ETFs and remaining three are long-term gilt. Recently, the Bharat Bond ETF by Edelweiss AMC was launched and is available for trading on exchanges. Bharat Bond ETF invests in corporate bonds of public sector enterprises. Among the other debt ETFs, Nippon India ETF Liquid BeES has the highest AUM of 2,194 crore. In terms of 1-year returns, Nippon India ETF long-term gilt (11.92 per cent) and DSP Liquid ETF (3.72 per cent) gave the highest returns in their respective sub-categories.

Gold ETFs
Gold ETF is the only commodity-based ETF currently available for trading on exchanges. As the name suggests, they track gold prices. There are around 11 gold ETFs that are available for trading. In terms of AUM, Nippon India ETF Gold BeES scores over other gold ETFs with an AUM of Rs 2,694 crore. However, when it comes to return then, Invesco India Gold ETF gave the highest returns (27.53 per cent) among other ETFs in 1-year.

Which ETFs Stand Tall?


Above are some of the top ETFs in equity, debt and gold. They have made to the top due to their AUM and long-term performance. In case of equity ETFs, they are not limited to the aforementioned categories. But they also have thematic ETFs like factor-based ETFs and international ETFs like Motilal Oswal Nasdaq 100 ETF and Nippon India ETF Hang Seng BeES. ETFs tend to give better long-term returns as they are very low in cost. Besides, you need to bear the transaction costs also, apart from the expense ratio.

How liquid are they?

Liquidity remains the major concern while investing in any instrument and ETF should be no different. However, liquidity in case of ETF is slightly different from normal stock market.

There are three layers of liquidity in an ETF viz visible secondary market, hidden secondary market and primary market.

Visible secondary market liquidity

Secondary market liquidity is said to be visible when the buying and selling happens at the exchange during market hours. Generally, higher the number of ETF unit holders, better is the visible secondary market liquidity. As the majority of the ETF trades are done in the secondary market, during normal market conditions, the liquidity of the ETFs would not be overly dependent on its underlying securities.

Hidden secondary market liquidity

Authorised Participants (AP) is also sometimes referred to as Designated Market Makers (DMM). These are the financial institutions which dynamically manage the creation and redemption of ETF units through AMC, to provide additional liquidity in the secondary market. These market makers provide liquidity by buying & selling ETF units and trying to keep bid-ask spread closer to the fair value of the ETF, which is represented by the Indicative Net Asset Value (iNAV) during the day.

Primary market liquidity

The third level of liquidity is via the AMC. Here, investors can create or redeem ETF units above specific basket size directly from the AMC. This will provide large investors with seamless access to the redemption and creation of ETF units. When AMC will receive a redemption request, it will sell the underlying securities and extinguish the units. On the other hand, when AMC will receive fresh investments, it will create new units by buying the underlying securities from the market.

So, as we can see that liquidity will not be a major concern for investors. If at all volume of the ETFs is low, there are APs that can create or redeem the units of ETFs which creates liquidity in the market.

Should You Invest In Them?

All in all, ETFs is one of the better ways of passive investment. Although, we are a developing economy, so, there are a lot of opportunities available for the actively managed funds to create an alpha. Nevertheless, as market becomes more efficient, we may see the alpha generated by the active funds declining. Investing in ETFs has its own set of advantages like low-cost product, can be bought and sold just like shares, and so on.

ETFs are more suitable to anyone who is new to equity investment. It will help him to get the experience of investing in equity as an asset class. It is better to invest in ETFs rather than in a single company as the volatility of an ETF might be low as compared to a single company. Also, it sets you free from the process of fund selection. Secondly, long-term investors can consider investing in ETFs as they can cash in the benefits of the low-expense ratio. Investor can also use ETFs to diversify their portfolio further, by investing in an international equity index.

So, does it mean they would replace the mutual funds? Not at all! Though similar, both the products are structured differently and investors can use them judiciously to achieve their financial goals.