Prod passive investing via index funds, not index ETFs

Cogencis, Wednesday, May 8

By Rajesh Gajra

NEW DELHI – The Securities and Exchange Board of India has, in recent months, been inclined to get swayed by those pushing exchange-traded funds as the only solution to problems of active fund management.

As such funds are plagued with problems such as low liquidity and high spreads, it makes more sense for a regulator to encourage investors to opt for passive investing through index funds instead.

Retail investors in new fund offers of exchange-traded funds can sell their units only on stock exchanges during trading hours, which exposes them to risks of poor liquidity and high spreads between the best buy and sell orders. And while large investors can buy and redeem units directly from mutual funds, in large lots, monthly disclosures of mutual funds don't include the quantum of changes in their core unit capital, which lends a touch of opacity.

In the case of the government-sponsored CPSE exchange-traded fund and Bharat 22 exchange-traded fund, large investors redeemed their holdings with the mutual fund two-three months after the new fund offer and further fund offers. Due to these large redemptions, the assets of these two funds were depleted by 60-75%.

Index funds, on the other hand, encourage passive investing in equities. Such funds achieve the same objective of zero tracking error as index exchange-traded funds. And, investors can buy and sell index fund units at the net asset value disclosed by a mutual fund, exactly as buying and selling any actively managed mutual fund scheme.

In terms of cost, index exchange-traded funds and index funds offer the same low-cost advantage compared with active funds. Though exchange-traded funds are touted to have a lower expense ratio than index funds, this isn't a given–there are intangible costs built in due to the high spreads in traded exchange-traded fund units.

As of Mar 31, the assets of index funds based on the Nifty 50, the Sensex and a few other broad-based indices stood at around 52 bln rupees, much lower than the total assets of exchange-traded funds.

Domestic assets of non-gold exchange-traded funds, predominantly equity ones, have grown 8.3 times in the last three years, even as equity indices have appreciated only around 50%.

Assets with exchange-traded funds had risen to 1.35 trln rupees as of March this year from 161 bln rupees as of March 2016.

The growth story, however, isn't based on a solid foundation, primarily due to two factors.

First, in the last two-three years, the Employees' Provident Fund Organisation has been taking equity exposure through select exchange-traded funds of SBI Mutual Fund and UTI Mutual fund. And, as of Mar 31, EPFO investments in exchange-traded funds were estimated to account for 54% of the 1.35-trln-rupee assets of all such funds in the country.

Second, the assets of CPSE exchange-traded fund and Bharat 22 exchange-traded fund together make up 19% of the total assets of exchange-traded funds.

If one discounts these two sources, assets with exchange-traded funds are at only 365.1 bln rupees. While this represents a good level, it is not phenomenal.

The government has been the primary driver of exchange-traded fund assets, and has a vested interest in popularising such funds among investors. This has also played a role in the recent marketing push by stock exchanges on which these funds are listed, as well as by the two fund houses–ICICI Prudential MF and Reliance MF–that manage the two disinvestment-targeted exchange-traded funds.

To protect the interests of all investors, SEBI should be wary of any marketing thrust by the government and other vested entities.

The two government-sponsored exchange-traded funds, which account for 19% of all assets with such funds, track the CPSE Index and the Bharat 22 index, which aren't well diversified.

Index funds, on the other hand, are primarily on broad-based indices such as the Nifty 50, the Sensex, the Nifty 100 and the Nifty Next 50, with a couple of them based on the Nifty Bank index.

While investors are likely to gradually shift from active to passive investing, both the index fund and index exchange-traded fund routes are open. Investors have to choose wisely between the two. SEBI could be an enabler.


* SEBI allows FPIs to invest in muncipal bonds

* SEBI finds governance lapse at NSE in Infotech Fincl-Ajay Shah case


* SEBI fines NSE in colocation case, takes action vs ex-MD, employees

* SEBI puts brakes on NSE's IPO, bars bourse from mkt for 6 months


  Date  Unit Latest Previous
FII/FPI net equity investment#     May-06 US$ mln 44.45 551.12
FII/FPI net debt investment#   May-06 US$ mln (-)0.27 (-)21.03
DIIs net equity investment#   May-06 bln rupees 4.26 (-)45.62
DIIs net debt investment#   May-06 bln rupees 12.93 (-)1.66



* Neogen Chemicals issue price set at 215 rupee, to list Wed

* Aditya Birla MF seeks SEBI's approval for PSU equity fund

* DSP MF seeks SEBI nod for close-ended income schemes


* NSE says SEBI strictures not to impact normal exchange functioning

* SEBI still lacks institutional mechanism to tackle external investigations (Mint)

* SAT grants interim stay on SEBI orders against OPG, GKN Securities (PTI)

* SEBI panel likely to recommend FPI investment in unlisted cos (ET)


Sources – Television, print, or Web editions of:

# – Data not available for May 7

ET–The Economic Times, PTI–Press Trust of India, Mint

Internet links:


Compiled by Pooja Sawant

Edited by Avishek Dutta

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