The year 2020 witnessed a surge in the number of Exchange Traded Funds (ETFs) launched along with substantial inflows into these products. The year also saw the rise of innovation in the form of thematic products such as ESG, Target Maturity Debt ETF, Smart-Beta ETFs etc coming to the market. What is more important is that the ETFs started gaining acceptance from retail investors also, apart from institutional investors who are significant investors in ETF already. ETFs have potential to provide different solutions that can cater to demands of various investors. Desired market exposure at low-cost through plain vanilla products like NIFTY 50 ETF or Bank ETF along with innovative products providing exposure to various themes and strategies can propel an ETF to become a significant investment product in the coming times.
In present context, industry wide AUM of all 100 ETFs at the end of February 2021 stood at Rs 271,198 crore showing a rise of 44% from Feb 2020. Though ETFs have been in existence in India for 20 years, the growth in ETF actually can be witnessed in the last 5-6 years. Some of the reasons which have contributed to rise in ETF AUM in India are:
- Government’s use of ETF as a preferred route for disinvestment has increased the participation of retail investors
- ETFs are being used by EPFO and private PF bodies to take exposure in the equity market
- Shrinking alpha in active fund space has made even an average investor aware about the benefit of plain vanilla ETFs like NIFTY, Sensex etc.
Further, what is exciting is to see a rise in participation of retail investors in ETFs. For instance, the number of retail folios in ETFs other than gold stood at 2,50,034 in December 2015. This has increased at an annual rate of 57% to 15,03,033 in December 2019. In the last one year, this has more than doubled to 33,81,776 folio in December 2020. It highlights that investors have adapted ETFs at a much faster pace than most of us would have anticipated.
This shift where investors want to add ETFs in their portfolio along with active funds is also because of the underperformance of the large cap mutual fund category in recent times. While some of the active fund houses have done well, but overall at an aggregate industry level, performance is lagging, which has made investors cautious about the cost that is being levied. The simplicity of the product is what makes ETFs more appealing. Apart from simplicity, the low cost, tradability feature, transparent portfolio, focused exposure and accessibility to buy and sell at intra-day net asset values has contributed to the rise and popularity of ETF.
Further, ETFs can be of various types because as long as underlying for an ETF is an investable universe which is represented by an index, there can be an ETF on it. Globally there are ETFs tracking broad-based indices, sectoral indices, fixed income indices, thematic indices, smart beta indices, commodities such as gold, silver etc. There are even leverage and inverse ETFs.
The most popular ETFs are obviously the one tracking broad based indices such as S&P 500, Nifty50 etc. The most important reason for them being popular is that over the time as discussed earlier the market becomes informationally more efficient and beating the benchmark becomes progressively difficult. Hence, ETFs which are available at very low cost and removes the fund manager risk of underperformance, becomes a compelling investment product.
Further, looking at global trends, there is a shift from once ETF being only used for the purpose of taking passive exposure in a broad-based index to today where ETFs are a preferred route of investment vehicle if somebody wants to capture and get benefitted from particular theme such as ESG, cloud computing, robotics, artificial intelligence etc. More and more ETFs are also being adopted to take smart-beta exposures in factors like momentum, low volatility etc.
Going ahead, if alpha continues to shrink specially in the large-cap segment, we may witness quick adoption of ETFs among the investors. Further, the pandemic has accelerated the need to diversify one’s portfolio. In such cases, ETFs become an excellent vehicle to invest in the foreign markets, themes and different asset classes. ETFs are thus, a great medium for an investor to take transparent, low cost strategic or tactical exposure in desired segments of the market based on his or her risk profile.
(The writer is the CEO of Mirae Asset, India)