What is your opinion about ETF investments? Since Value Research has been supporting direct schemes of mutual funds due to lower expenses, don't you think ETFs 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 Value Research/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 the indices by 3 to 4 percent points a year, while mid-cap 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 sectoral indices) and it has proved quite easy for fund managers to pick quality stocks outside them to deliver large outperformance.
Globally though, a majority of active funds struggle to beat the 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 ETFs by a margin. Also, you should remember that ETFs involve brokerage charges over and above fund management expenses and could trade at a premium or discount to their underlying NAVs.
We can compare regular and direct plans of a scheme with respect to the cost structure only because the underlying portfolios are the 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, since 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 indices, respectively. Sectoral ETFs are riskier 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.
This article was originally published on August 25, 2015.
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