India Equity ETFs Worth Considering
(This
is for information purposes only. This should not be construed as a
recommendation or investment advice even though the author is a CFA Charterholder. Please consult your financial
adviser before taking any investment decision. Safe to assume the author has a vested
interest in stocks / investments discussed if any.)
Mutual funds are basically pools of money collected from many investors and these pools are professionally managed by experienced fund managers. Mutual funds in India are regulated by SEBI or Securities and Exchange Board of India, India's capital market regulator.
Mutual funds can be passive or active. With active funds, a fund manager has the flexibility to invest in securities (basically stocks or bonds) across a wide range of securities, according to the mandate of a particular mutual fund scheme.
In case of passive funds, a fund manager has to invest in securities of the underlying index and in the same proportion as they are in the index. Unlike active fund managers, passive fund managers don't have the flexibility of investing -- they need to stick to investing in securities of the underlying index.
2. Exchange-Traded Funds or ETFs
Exchange-traded funds (ETFs) are a type of passive mutual funds, which can be
traded on stock exchanges. You can buy or sell an ETF on a stock
exchange, like you buy or sell a stock.
(the blog continues below)
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The underlying of an ETF can be stocks, bonds or even other assets, like, gold and silver. There are more than 180 ETFs in India based on indices, like, Nifty 50, Nifty Next 50, Sensex, Nifty Bank, Nifty Bharat Bond index, BSE Liquid Rate index and BSE Quality index.
For example, you take an equity ETF where the underlying index is Sensex, namely, LIC MF Sensex ETF. This ETF invests in stocks that are part of the Sensex and in the same proportion as in the Sensex.
Sensex has a total of 30 stocks. As the name suggests, LIC MF Sensex ETF is based on Sensex. The ETF will invest in the 30 Sensex stocks in the same weights as the underlying stocks have in the Sensex. Instead of buying all the 30 stocks in Sensex, one can directly buy an ETF based on the Sensex.
Basically, an ETF replicates the underlying index. ETFs seek to achieve the same return as the underlying market index. In the example quoted above, LIC MF Sensex ETF will try to achieve the same return as that of the Sensex index.
3. Growth of ETFs
The assets of ETFs (other than gold ETFs) have grown by more than six times in the past five years -- from Rs 90,000 crore in Sep2018 to Rs 5.60 lakh crore in Sep2023. The growth of ETF assets is mainly aided by EPFO or Employees' Provident Fund Organisation, increased retail participation and general rise of Indian stock market.
Table 1: Growth of ETF Assets in India:
As per data from Rupee Vest, there are more than 140 equity ETFs in India with a total assets under management (AUM) of Rs 4.70 lakh crore. The top 10 equity ETFs, by asset size, have a combined AUM of Rs 4.07 lakh crore as at the end of September 2023.
4. ETF Selection Criteria
The following six criteria area are important while choosing ETFs and they are: suitability, portfolio diversification, size of assets, expense ratio, tracking error and liquidity. For a more detailed discussion on this, please check the blog dated 12Sep2023.
5. Broad-based equity ETFs
It'a big challenge for equity investors to select from a forest of equity ETFs. There are various types of ETFs based on indices, like, Sensex, Nifty Next 50, Nifty Midcap 150, BSE 100, Nifty Bank, BSE Healthcare and Nifty Smallcap 250.
Compared to active mutual funds, passive funds, like, ETFs are better for retail investors, who lack the sophistication of institutional investors and high net worth individuals (HNIs).
Why is it so? As detailed in various research reports over the past 55 years, active mutual funds have been consistently failing to beat passive mutual funds.
In the US and other major countries, ETFs have a lot of liquidity and market breadth. But in India, only a handful of equity ETFs have good liquidity.
Liquidity is represented by transaction volumes of a particular ETF on stock exchanges (on NSE of National Stock Exchange of India or BSE Ltd) and the value of such transactions.
The liquidity data are provided by NSE and BSE on a daily basis. It's much easier to sell or buy ETFs, which have high trading volumes and low bid-ask spreads.
Novice investors can stick to ETFs based on broad indices, like, Sensex, Nifty 50 or Nifty Next 50. Details are provided in table 2 below:
The next question to ask is what are the names of such broad-based ETFs that are worth considering by young investors. The details of such schemes are provided in table 3 and 4 below.
These tables provide names of ETFs, their asset size, inception date, benchmark index, returns, risk ratios and others.
AUM data are as of 30Sep2023 and return data are as at the end of 13Oct2023.
The following filters are used to arrive at the above eight equity ETFs:
(i). ETFs with AUM of less than Rs 250 crore are removed.
(ii). ETFs with less than 3-year record are removed.
(iii). Nifty 50 and Sensex ETFs of SBI and UTI are removed as they suffer from big investor risk. This is a unique risk (EPFO risk) peculiar to Indian ETFs. EPFO is a big investor in these ETFs; hence, it's not advisable to invest in schemes in which EPFO invests -- these broadbased ETFs are removed even though they are having high liquidity / trading volumes on stock exchanges (NSE and BSE).
In general, ETFs with high assets tend to have high volumes; hence, ETFs with low assets based on a particular benchmark index are removed.
However, it's better for investors to check the trading volumes of a particular ETF for a period of three or four years before making investment decisions. It's also advisable to check other parametres, like, age of an ETF, tracking error, expense ratio, bid-ask spread and others, before making investment decisions.
The
problem with daily volume data is the volumes are dependent on
asset size of ETFs, investor fancy, investor euphoria over a particular
sector and general enthusiasm about stock market.
One can assess volumes and liquidity data of select ETFs as detailed in the blog on Nifty 100 Low Volatility 30 ETF (please refer table 6 of the blog).
Finally, what we're left with are select equity ETFs; in each benchmark, two ETFs are selected --but in a few only one ETF is available; and ETFs with high assets are selected.
ICICI Pru S&P BSE 500 ETF has assets of only Rs 126 crore - it's included in tables 3 and 4 just for comparison purposes. One attraction of this ETF is it has 501 stocks and is a bet on the assumption that India would do well in the next five to 10 years.
BSE 500 is a well-diversified index, like its counterpart in the US, the S&P 500. Passive funds based on BSE 500 provide good portfolio diversification. One can consider such passive funds provided they have decent asset size of more than Rs 250 crore and good liquidity.
In general, it's not a good idea to invest in ETFs with small asset size. Unless the asset size is more than Rs 250 crore, ETFs will not have good liquidity (this is just a gut feeling, there is no data to back up this claim). So, it's better to avoid ETFs with small asset size and low trading volumes / liquidity.
While
selecting the above equity ETFs (table 3 and 4), the author has his own biases and
preferences. Investors must check the volumes and liquidity of a
particular ETF; and verify the other selection criteria mentioned in
section 4 above.
6. Thematic / Sectoral Equity ETFs
An important tenet of equity investing is portfolio diversification. Holding a portfolio of, say, just five stocks is highly risky. If two or three stocks do badly, the investor's portfolio too will suffer heavily.
On the other hand, when your portfolio has at least 30 stocks, even if three or four stocks give poor returns, the impact of poor returns on the overall portfolio will be minimal -- providing downside protection for investors.
List of such narrow thematic / sectoral indices:
It's important to have at least 25 to 30 stocks in a well-diversified portfolio. Unless the underlying index has 25 to 30 stocks, it's better to avoid ETFs based on such stock indices.
One peculiar feature of equity ETFs in India is capital market regulator SEBI allows ETFs based on indices that have less than 20 stocks -- for example, Nifty CPSE has 11 stocks, Nifty IT has 10 stocks and Nifty Private Bank has 10 stocks.
These indices with a small number of stocks suffer from concentration risk. In these indices, top three or four stocks will have a weight of more than 60 percent in the index.
In times of a market meltdown, ETFs based on such sectoral and narrow indices suffer severe falls. It is not clear why SEBI allows such narrow indices that are vulnerable to high concentration risk.
While assessing exchange-traded funds, it's advisable to know about all kinds of ETFs. Hence, details of equity ETFs based on narrow thematic / sectoral indices are provided in tables 6 and 7 below.
Most of the ETFs mentioned in tables 6 and 7 are not suitable for long-term individual investors. Even though its assets size is less than Rs 250 crore, DSP Nifty 50 Equal Weight ETF is included here for comparison purposes.
AUM data are as of 30Sep2023 and return data are as at the end of 13Oct2023.
If
at all you have expertise in choosing narrow sectoral / thematic funds, you
can consider a few of them based on your investment goals, risk
appetite, suitability and other criteria.
7. Summary
Equity exchange-traded funds are simple and easy to understand financial products. Most of the equity ETFs in India suffer from low liquidity (low trading volumes on stock exchanges and high bid-ask spreads), high concentration risk, lack of portfolio diversification in the underlying index, small asset size and low investor participation and interest.
As of 30Sep2023, there are more than 75 equity ETFs with less than Rs 100 crore of assets. Some ETFs have no trading volumes at all on some days. No wonder asset management companies (AMCs) are often castigated as asset mismanagement companies -- interested only in asset gathering rather than asset management.
Hence, it's better for young and unsophisticated investors to stick to equity ETFs based on broad market indices with decent asset size and high trading volumes, like those based on Sensex, Nifty 50 and Nifty Next 50 -- as detailed in section 5 above. They can avoid ETFs where the underlying indices are narrow thematic / sectoral -- as detailed in section 6 above.
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Related Blogs on Mutual Funds:
Analysis of Nifty 100 Low Volatility 30 Index
EPFO Investments in Stocks Via ETFs
Compare ETFs based on S&P 500, Russell 2000 and MSCI EM
ETFs compare Nifty BeES and Junior BeES
Who is Eating My Gold ETF Return?
India Equity ETFs Risks and Returns
Passive Investing - ETFs and Index Funds
Why I Won't Invest in FFO of CPSE ETF
Junior Nifty BeES ETF
Nifty BeES ETF
Compare BSE 500 and S&P 500 Indices 31Mar2023
Quarterly data of MF assets in India 21Apr2023
Mutual Fund Asset Class Returns 31Mar2023
Understanding Corporate Debt Market Development Fund (CDMDF)
Negative Impact of Debt Mutual Fund Tax Changes
NSE Indices (Nifty 50, Nifty Next 50, Nifty 100 and Nifty 500) comparison 31Dec2022
Why Do Indian Equity MFs Always Disappoint Investors?
Indian Mutual Funds and the Art of Ripping off Investors
Mutual Fund Asset Class Returns 31Mar2023
Mutual Fund Asset Class Returns 31Dec2022
Mutual Fund Asset Class Returns 30Jun2022
Mutual Fund Asset Class Returns 31Mar2022
Mutual Fund Asset Class Returns 31Dec2021
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Disclosure: I've vested interested in Indian stocks and other investments. It's safe to assume I've interest in the financial instruments / products discussed, if any.
Disclaimer: The analysis and opinion provided here are only for information purposes and should not be construed as investment advice. Investors should consult their own financial advisers before making any investments. The author is a CFA Charterholder with a vested interest in financial markets.
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He blogs at:
https://ramakrishnavadlamudi.blogspot.com/
X (Twitter) @vrk100
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