Is it right to invest in ETFs?

For the one-year period ended June 2021, 86.2% Indian Equity Large-cap Fund, 57.1% Mid- or Small-cap and 53.7% Equity-Linked Savings Scheme or (ELSS) Fund underperformed their respective benchmarks. As per the latest S&P Index vs Active (SPIVA) India Scorecard report.

Over the past few months, ETFs have grabbed headlines. Leading stock exchange, National Stock Exchange of India (NSE), said in July that the number of ETFs listed on its platform has reached 100.

“Many active funds have started performing poorly for a while. Beyond that, AMC would like to maintain its flow in some fashion. Passive strategy has been in flavor over the years and the fund house has also launched some unique investment themes,” said Rishabh Desai, a Mumbai-based mutual fund distributor.

Moreover, since the beginning of the financial year, the fund house has launched a total of 11 ETFs in the Indian market. Even HDFC Asset Management Company Ltd filed papers for nine ETFs with the Securities and Exchange Board of India (SEBI) within two days in the first week of October.

An ETF, or exchange-traded fund, is a marketable security that tracks a basket of assets, like an index, commodity, bond, or index fund. ETFs are funds that track an index like Nifty or Sensex. The main difference between ETFs and other types of index funds is that ETFs do not try to outperform their respective indexes, but instead replicate the performance of the index.

On the other hand, an index fund works like a mutual fund scheme, in which a fund manager creates a portfolio that mimics an index, which could be Sensex or Nifty. But index funds can buy them only at the end of the day’s net asset value (NAV).

“I generally do not recommend my clients venture into ETFs because of two factors. The first is that ETFs can be traded at a premium, and there may be a price dislocation between the actual price and the traded price. Hence, investors can bear some opportunity losses. Secondly, there may be liquidity issues when the investor wants to exit the issue.”

The expert said that only if there is no unique theme available in the index category, then one should only come in the ETF.

Unlike index funds, a major advantage of ETFs is that they are traded like common stocks, and can be bought or sold on a stock exchange.

However, investors should be aware of the tracking error in ETFs, which is the difference between the return of an index and the fund that tracks it. A high tracking error suggests that the fund is not actually replicating the index due to high cash or expense levels or a separate allocation to stocks. This exposes it to the risk of deviating from its mandate.

Low-cost passive investments such as index funds and ETFs are good long-term options, but make sure you are getting the benefits of low-cost, efficient transactions in the instrument you choose.