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Actively-managed Funds score over ETFs

We recommend actively-managed funds over ETFs because the former can outperform indices by a large margin

Of late we have been hearing a lot about ETFs. NSE India also advertises for ETFs. I do understand that investing in ETF comes at a much lower management cost because these are passively managed as against MFs which are managed by professional fund managers and charge a fee of around 2-3 per cent. What is your opinion about ETF investments? Since VR has been proposing direct schemes of MF to have lower expenses, don't you think ETF will be even better? Are ETFs like Bank BeES and PSU Bank BeES sectoral in nature? Will this not defeat the basic purpose of diversification as promulgated by VRL/other experts all the time?
- Girish Sidana

Value Research has been recommending actively managed equity funds with a good track record over ETFs because these funds outperform the indices by large margins in India. Evaluating fund returns over the last ten years, the top performing large-cap funds have beaten indices by 3 to 4 per cent a year, while midcap and other categories have delivered even bigger outperformance of their benchmarks.

The typical indices in India for which ETFs are available are narrow (Sensex, Nifty or sector indices) and it has proved quite easy for fund managers to pick quality stocks outside them to deliver large out-performance.

Globally though, a majority of active funds struggle to beat indices and ETFs have been very popular as a result. ETFs offer a simple and low cost avenue to invest in equities as they just mirror an index without trying to outdo the market. They charge much lower expenses than active funds. For instance, Goldman Sachs Nifty Bees charges a nominal 0.54 per cent annually against an average of 2.5 per cent charged by diversified equity funds.

However, this cost differential will be justified as long as active funds, after accounting for expenses, are able to beat the ETFs by a margin. Also, you should remember that ETFs involve brokerage charges over and above the fund management expenses and could trade at a premium or discount to their underlying NAV in the markets.

We can compare regular and direct plans of a scheme upon cost structure only because the underlying portfolios are same. So, lower expenses will simply translate into higher returns. But comparing two categories of funds just on the basis of expenses is not correct where investment strategies and portfolios can differ tremendously.

Referring to the second part of your query, yes, ETFs like Bank BeEs and PSU Bank BeES are sectoral in nature as they replicate CNX Bank and CNX PSU Bank respectively.

Sectoral ETFs are more risky than Nifty or Sensex tracking ETFs because their performance relies on how a sector or theme performs in the market. Themes like PSU banks can outperform or underperform significantly depending on market conditions and you should know when to enter and exit from the theme.

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