Exchange Traded Funds: A Newcomer to the Neighborhood
Globally, exchange-traded funds (ETFs) have been around for quite some time. Even in India, the first set of ETFs date back decades, but their relative popularity has been low so far.
The main causes of a jump in popularity were no different from global trends: a need for diversification of national markets, a move away from active managers consistently underperforming major indices (82% of large-cap fund managers underperformed). -performed the S&P BSE100 Index over the past five years according to the S&P SPIVA 2021 Year-End Report), and the rapid evolution of discount brokers and portfolio management or advisory platforms that have made l easier and cheaper investment.
Not only that, the tools available to individual investors to manage investments have also exploded, as have the knowledge levels of advisors (small as they are now), as simple to understand, powerful and diverse investing. Simply put, an ETF is a basket of stocks, bonds, commodities, or other investments where the units of those baskets (or funds) are traded on an exchange, hence the name exchange-traded fund. .
The ease of use of ETFs is also an important factor in asset allocation. It allows low-cost one-time transactions (as small as Rs 20-30 in some cases), making them ideal democratic products for large pension funds such as EPFO and individual investors.
For ETFs, an exchange allows investors to target a certain price, unlike traditional mutual funds which have blind entry/exit pricing, i.e. it is not known at what price they buy or sell a fund. Additionally, there are no charges or entry/exit restrictions and management fees tend to be lower for ETFs (NiftyBeeS operates at an expense ratio of around 0.06%).
With lower risk comes low expense, as the turnover (different companies entering or exiting the underlying index) is quite low as it is not expected to outperform benchmarks.
The catch is that buying and selling ETFs, like stocks, is not without its complications. Although the process is quite simple, there are some things to be aware of like iNAV (intraday net asset value), premium discount and price dislocations, if any. The price of an ETF depends on demand and supply as well as the net asset value of the basket. When demand is greater, the ETF trades at a premium: similarly, an oversupply can lead to a discount.
The Exchange Traded Fund’s indicative net asset value (iNAV – 10s to 30mins ETF instantaneous net asset value) is calculated and published continuously by the fund managers in India.
While the iNAV reflects the value of the constituent stock, the price of the ETF unit reflects market interest based on the participant’s view of the underlying basket, providing transparency, intra-day liquidity and thus a better discovery of prices.
For example, the difference between the net asset value and the quoted price may present an arbitrage opportunity that could lead to the creation of units or the redemption of existing units.
The iNAV conundrum becomes more interesting when the components of the ETF portfolio do not trade during Indian market hours (NASDAQ100 – ETF MON100) or trade around the clock (ETF gold or silver). Traders use strategies that do not rely on iNAVs published by AMC and instead look to such global markets as CME Globex to determine ETF value. For example, it is better to use the Nasdaq 100 e-Mini futures rather than the iNAV.
However, all these calculations and complications may not be everyone’s cup of tea. Two choices can therefore be a) use index funds instead of ETFs which are easy to buy/sell although a bit expensive or b) create a self-rebalancing portfolio using market transactions on platforms like Wealthdesk. These basic ETF-based portfolios are inexpensive, tailored, and suitable for most financial goals an investor may have.
(The author is partner, Infinity Alternatives)
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