The assets of exchange traded funds or ETF is increasing globally at a fast pace. Global assets under management (AUM) in ETFs multiplied 10 times in the last 10 years ending 31st December 2021. As per Statista, global assets under management in exchanged traded fund reached $10 Trillion in 2021 (as on 31st December 2021).
ETFs in India
While a large part of the exchange traded fund global AUM is from the developed markets, the popularity of ETF mutual fund is growing rapidly in India as well. In the last 3 years assets under management (AUM) in ETFs in India grew at a compounded annual growth rate of (CAGR) 45% (source: AMFI, 29th July 2022). With AUM of over Rs 4.5 crores ETF is the largest category of mutual funds in India (source: AMFI, 29th July 2022). Around 30 new ETF were launched in India in the last 12 months (as on 19th August 2022). We now have ETFs across several asset classes e.g. equity, debt, gold, silver etc. We also have ETF mutual fund schemes for multiple market cap segments and industry sectors.
What is ETF?
Exchange traded funds (ETFs) are passive schemes that track benchmark market indices (e.g. Nifty, Bank Nifty etc) or prices of commodities (e.g. Gold, Silver). ETFs invest in a basket of securities that replicate the benchmark market index ETFs do not aim to beat the market aims they are tracking; they simply aim to give market returns subject to tracking errors. ETFs are listed on stock exchanges and are traded like stocks. You need to have Demat and trading accounts to invest in ETFs
Benefits of investing in ETFs
- Costs or Total Expense ratios (TER) of Exchange Traded funds are much lower than actively managed mutual fund schemes. TERs have a direct bearing on return because TERs get adjusted in scheme mutual fund NAV. In order to match or outperform ETF returns, an actively managed fund with same benchmark index as the ETF will have to beat by a margin that in percentage terms is as much as the difference in TER of the active fund and ETF. For example, if the TER of an ETF is 0.1% and that of an active fund with the same benchmark mark index is 2%, then the active fund will have to beat the benchmark by 1.9% in order to match the performance of the ETF.
- Actively managed mutual fund schemes have to be overweight / underweight on certain stocks or sectors relative to the benchmark index since they aim to beat the benchmark index. This gives rise of unsystematic risk in the scheme. Unsystematic risk is the incremental risk over and above market risk, which all mutual funds are subject to. ETF are only subject to market risk. There is no unsystematic risk in ETFs because they invest in a basket of securities that replicate the market index.
- Unlike actively managed mutual fund investment, there is no fund manager bias in ETFs. Different active funds may outperform or underperform at different points of time because of this bias. Since there is no fund manager bias in ETFs, they are much simpler to select. An ETF with lower TER and tracking errors will outperform other ETFs tracking the same benchmark index.
Retail investments in ETFs took off in a big way during the COVID-19 pandemic. In this article, we discussed what ETF is and the benefits of investing in ETFs. Investors should consult with their financial advisors if Exchange traded funds are suitable for their investment needs.