Exchange traded funds (ETFs) : low-cost investment vehicle that provides diversification
Mr. Chintan Haria
Fund Manager &Head- Product Development & Strategy,
ICICI Prudential Asset Management Company Limited.
Q. Could you give us an overview of ETFs in India?
A. The first ETF in India was launched in 2001 which tracked the performance of the NIFTY 50 Index. Since then their reach has not only increased manifold but also diversified across various sectors/asset classes. We now have a bouquet of large-cap, mid-cap, sectorial/ thematic based ETFs, Gold ETFs, etc. to choose from. ETFs are best suited for investors who are keen on tracking their performance based on an underlying index and seeking diversification benefits at a low cost.
Assets under Management for ETFs in India has grown to approx. Rs. 152,802 crores over the years. One of the major contributors to this growth was Employees’ Provident Fund Organisation’s (EPFO) announcement that it would take equity exposure only via ETFs and the decision by the Government of India to divest in the Public Sector Units through ETFs. Recently, we have also seen that passive funds have outperformed the market mainly due to the performance of broad market indices.
ETFs are best suited for investors who are keen on tracking their performance based on an underlying index and seeking diversification benefits at a low cost.
A concept that is gaining attention in recent times is that of Smart Beta ETFs. It is a perfect blend of active and passive investing where a rules-based, systematic approach is used to choose stocks from a particular index. Smart Beta ETFs are ideal for investors hoping to maximize their income and returns while also allowing for the potential to minimize risk.
Q. What are the different types of ETFs?
A. ETFs can be broadly classified into:
1. Equity ETFs: Equity ETFs are the most popular ETFs and track the performances of equity across various capitalizations, sectors, themes, etc.
2. Debt/Liquid ETFs: Debt ETFs primarily invest in bonds/debentures or money market securities issued by the government or corporations. Liquid ETF invests in TREPS.
3. Commodity ETFs: Commodity ETFs invest in precious metals like gold, agricultural goods, etc. Gold ETFs are the best example of this category.
Q. What are the parameters one should analyze while selecting ETFs for investment?
A. The following parameters should be assessed to select the apt ETF for investment:
• Underlying Index or Asset: Investors should go for an ETF that is based on a broad, widely followed index, or an index that has a narrow industry or geographic focus based on their preferences.
• Tracking Error: Not all ETFs can mirror the performance of their benchmark index. This difference is called the tracking error. Hence, an ETF with minimal tracking error is preferable to one with a greater degree of error.
• Liquidity: An ETF with higher liquidity i.e. trading volume is preferred to an ETF that is infrequently traded to facilitate ease of exit when desired.
Q. Can one use the SIP (SEP) route to invest in ETFs? Ideally how many ETFs & what category of ETFs should one have in the portfolio if the target is to invest for a long term horizon?
A. A portfolio that consists of equity ETFs, debt ETFs and gold ETFs can be used to provide investors with the benefits of diversification across various asset classes.
Within equity, the allocation can be made to large-cap ETFs like Nifty 50, Nifty Next 50 index as large-cap companies are generally regarded as leaders in their respective sectors and provide steady growth over long periods of time. Allocations can also be made to liquid ETFs which are considered relatively safe and highly liquid and to Gold ETFs which acts as a natural hedge to equities during volatile market conditions.
The stated strategy may help investors achieve reasonable risk-adjusted returns over a long period of time and can be rebalanced annually or as the case may be.
Q. Is gold ETFs a good option only for hedging? Can investors use these as a proper investment tool?
A. Gold is that commodity which is globally accepted as a safety haven and provides shelter against market downturns and inflation. Gold, in India, holds a lot of traditional value and is stocked up in lockers in its raw or processed form. While it is always an option to stock physical quantities of gold, it is a good choice to opt for Gold ETFs to hedge risks. Gold ETFs are loaded with benefits such as ease in the transaction, hedge against inflation, tax benefits, backed by high-quality gold, small investments, etc. which makes it a good investment tool for investors.
Q. Where do you see the ETF market in India headed in the next few years?
A. ETFs are gaining momentum and are best suited for investors who lack sufficient knowledge but want to gain exposure to a variety of securities. The increasing awareness about ETFs being a low-cost investment vehicle that provides diversification is making it attractive by the day to retail investors.
A concept that is gaining attention in recent times is that of Smart Beta ETFs. It is a perfect blend of active and passive investing. It seeks to move away from the market capitalization-based weighting patterns and use a rules-based, systematic approach to choose stocks from a particular index. They seek to enhance returns, minimize risk and diversify by investing based on single factors like volatility or value or a combination of factors. Smart Beta ETFs are ideal for investors hoping to maximize their income and returns while also allowing for the potential to minimize risk.
The assets under management (AUM) of exchange-traded funds (ETFs), both equity and debt have seen a tenfold jump and as of September 2019- AUM in India stands at Rs 152,802 Crores and is expected to continuously grow.
About the Author: Chintan anchors Product Development and Strategy at ICICI Prudential AMC, where he is responsible for driving new product initiatives across business lines and working closely with the respective teams to augment business growth. He joined the company in October 2005 as a member of the equity dealing desk and rose through ranks to become a fund manager.
He continues to manage ICICI Prudential Equity Income Fund & ICICI Prudential Value Fund- Series 3. With an overall experience of more than a decade, his core competency lies in portfolio management, derivative strategies, and market intelligence.
In terms of investing style, Chintan uses a combination of top-down and bottom-up approaches and is valuation conscious while creating the portfolio. His stock-picking style is flexible, allowing both growth- as well as value-styled picks. However, valuations play an important role, as he avoids investing in expensive stocks/sectors even in his growth picks.
Chintan received a Masters in Commerce from Sydenham College of Commerce and Economics in 2005 and is a Fellow Member Chartered Accountant (FCA) from Institute of Chartered Accountants of India (ICAI). He is an Associate Member of Cost and Management Accountancy (ACMA) from the Institute of Cost & Works Accountants of India (ICWAI).
He also holds a Masters in Financial Analysis (MFA) and Chartered Financial Analyst (CFA) from the Institute of Chartered Financial Analysts of India (ICFAI). Further, he is a Certified Management Accountant from the Institute of Management Accountancy, USA.
The views expressed in the article are personal views of the author and do not necessarily represent the views of ICICI Securities
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