Exchange Traded Funds (ETFs) are the preferred route for investors in developed markets, for passive investing. Expenses charged to investors in ETFs are extremely low as these funds passively track the underlying index.
Average expense ratio charged by ETFs listed in India was 0.3 per cent of the fund’s asset, as on March 2017. This compares quite favourably with 2.5 per cent expense ratio of actively managed funds.
The arguments put out in favour of index funds apply to ETFs too. An investor with a low risk appetite, who prefers only large-cap funds, would be better off investing in index funds on Nifty or Sensex or an ETF on Nifty or Sensex.
However, there are more options in ETFs when compared to index funds. ICICI Pru’s NV20, for instance, invests in 20 most liquid bluechips. Reliance has the maximum number of thematic ETFs based on consumption, infrastructure, Shariah investing and so on. Both S&P Dow Jones in association with the BSE and the NSE have constructed many interesting indices that can suit most investors’ risk and return expectations.
For instance, the Nifty Quality 30 index includes companies that have a strong business and have shown a sustained improvement in margins and earnings. Stocks are selected based on ROE, debt-to-equity and profit growth, etc.
Indices such as the S&P BSE Greenex and the S&P BSE Carbonex can help you contribute towards a cleaner environment.
Problems galoreDespite the promise, ETFs are not popular in India. There are just around 47 equity ETFs listed on Indian exchanges, compared with more than 1,000 ETFs listed on the New York Stock Exchange, Deutsche Borse and London Stock Exchange.
Retail interest was high when gold ETFs were popular, prior to 2011. But since then, retail investors have withdrawn from the ETF segment. Only ₹50 crore of ETFs are traded on the exchanges daily. This lack of depth can, in turn, lead to tracking error (difference between traded price and the underlying index).
The reason why ETFs are not popular is because mutual funds do not make any special effort to market them. Distributors also do not promote them aggressively since they seldom get commission on selling ETFs. That ETFs need both trading account and demat account is also considered a deterrent by some.
Since demand is low, fund houses have not launched new products. This is leading to a chicken-and-egg situation as lack of options is affecting demand. But the menu can be widened if other strategic and thematic indices launched by the BSE and the NSE are used to issue ETFs. Only when ETFs become more popular can passive investing really gain ground.