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ETFs are fine, but we recommend index funds instead

LiveMint logoLiveMint 05-06-2017 Kayezad E. Adajania

Till now, there were five passively managed funds in Mint50, with a mix of index funds and exchange traded funds (ETFs). Typically, we prefer ETFs because of their superior structure, low tracking error and therefore lower costs compared to index funds at large. But ETFs also have disadvantages, one of which is lack of liquidity. On many days, not enough ETF units are available for sale, and not always at the price you may want them for. Also, their price rises as the amount bought goes up. 

For example: on 30 May, about 101,000 units of SBI ETF Nifty 50, largest passively managed fund in India, were available around noon on the National Stock Exchange. You could buy up to 7,000 units for Rs96.78 each. If you wanted more, the next 30,000 could be had for Rs96.89, the next 25 units for Rs96.90 and so on. The price goes up as quantity bought goes up. This is called impact cost, which can impact how much you finally save from buying ETFs, compared to say an index fund. Index funds typically have higher expense ratios than ETFs.

Then, there are some ETFs that are priced at 1/10th or 1/100th of their Nifty value or its equivalent. To know the liquidity on a given day, you also need to check your ETF’s net asset value and not just the number of units available.

Responding to reader feedback, we have tweaked our approach. Although ETF liquidity has improved over the last 2 years, you could find it bit tough to sell ETFs in an urgency. Hence, for now, we have removed ETFs from Mint50 and stick to index funds. ETFs are superior to index funds, so if you find a consistently liquid ETF that you can easily buy and sell on the stock market, instead of having to go to your fund house, you may go for it. Else, stick to the index funds, if a passively managed index fund is what you are looking for. 

Before we tell you what’s in and what’s out, let’s get something else out of the way. 

We’re bumping HDFC Equity and HDFC Top 200 Funds (HT200) to ‘core’ funds, up from the ‘satellite’ section of their respective categories. After losing close to 6% in 2015, it has returned close to 30% in the past 1 year. HDFC Equity Fund (HEF) lost 5% in 2015, but returned around 31% in the last 1 year, in a year that the Sensex did 16.80%. The funds had suffered in the past few years on account of their high holdings in state-owned banks, particularly, State Bank of India, and also because their fund manager Prashant Jain, executive director and chief investment officer, HDFC Asset Management Co. Ltd, had invested in cyclical goods sectors, expecting the economy to turn around. 

Things have changed since. Experts say that the worst has passed, as far as identifying SBI’s non-performing assets is concerned. The concerns may still be there, but the bank’s share price have gone up by 45% over the last 1-year. 

The schemes’ positioning towards an economic recovery—which meant HT200 takes some contrarian calls— also helped. As per mandate, HT200 sticks closely to the index and its common holdings with its benchmark index (BSE 200) should be at least 60%. For instance, if a company constitutes 5% of BSE 200 and 7% of the fund, the common holding is 5%. So, it does not hug the benchmark but does restrict the risks that typical equity funds can take on.

“Our portfolios are poised for lower and stable interest rates and therefore a recovery in capital expenditure. The recovery in corporate banks, metals and engineering companies also helped us,” says Prashant Jain.

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