When you have Shikhar Dhawan explaining ETFs on national Television in an overtly highly-priced IPL ad spot, you know that they have genuinely arrived in India. There are 90+ ETFs managing more than INR 2 trillion (~$27 billion) across asset classes. However, this is nevertheless a trickle compared to the US, exactly where there are 2,000+ ETFs managing more than $4 trillion. So, it would be fair to say that we are nevertheless in the early days of ETF (Exchange Traded Fund) adoption in India.
ETFs as a idea originated only about 25 years ago, but they have immediately captured the fancy of each institutional and retail investors about the globe. They have been initially promoted as a low-expense, index-investing solution vis-à-vis mutual funds. Index investing itself is an age-old idea, created well-known in the 1970s by John Bogle, the founder of Vanguard Group which is 1 of the biggest asset managers in the globe with more than $6 trillion in AUM (Assets Under Management). Today, just the best 3 ETFs that track the S&P 500 handle more than $730 billion.
One of the important factors ETFs have come to be so well-known in the US is that hedge funds and active managers have normally underperformed the S&P 500, specially more than the final industry cycle of 5-10 years. It appears like the similar story is playing out in India also. Performance information shows that the best 5 AMCs in India (that account more than 50% of AUM in equities) have been unable to produce alpha more than the index in the final 5 years. So, on the face of it appears like ETFs that just track the index (“Passive ETFs”) are a improved bet for investors. The key draw of Passive ETFs comes from economies of scale, whereby big ETF providers can offer you index tracking funds at close to zero costs.
So, the all-natural equilibrium for the ETF sector is that a handful of ETFs will account for most of the AUM. In addition, the underlying stocks in an ETF require to be liquid to decrease tracking error (distinction amongst ETF and index returns) and maximize enough entry/exit liquidity for investors. As a outcome, big cap ETFs that mostly track the Nifty 50 and Sensex (a basket of 30 stocks) account for more than 80% of total AUM in India.
While ETFs do offer you a expense-powerful solution and quick access to equity markets for investors, there are broadly two places of concern:
1. Large passive ETFs in the US are generally blamed for more volatility and concentration threat, because they manage a big element of the pie. They can drive sharp movements in the markets (as observed this year in March), considerably a lot more often than prior to the dominance of ETFs. This could simply occur in India also, specially offered the lack of industry depth right here.
2. In addition, because ETFs mimic the index weights for person stocks, they work in the favor of preserving the status quo. Hence, they could exacerbate the dominance of a handful of stocks. Already, just the best 30 stocks (~1.25% of the total quantity of listed firms on the NSE) by industry capitalization contribute ~49% of the whole industry. From an ETF investor’s point of view, this suggests lack of diversification in her portfolio with insufficient exposure to mid and modest caps.
I think the answer lies someplace in amongst the two broad solutions obtainable to investors currently i.e., systemized passive investing (passive ETFs) and active investing (human professional driven MFs/PMSs and so on.). The future is a new class of investing, Systemized Active, which is standardized guidelines-primarily based investing that delivers robust returns and diversification without having feelings-driven human biases.
Over time the SEC (SEBI-equivalent in the US) has modernized their regulation framework whereby they have created it simpler to produce ETFs, to drive innovation and competitors amongst providers. As a outcome, the quantity of ETFs in the US currently are comparable to the quantity of person stocks! Although the best 30 ETFs manage more than 40% of the total AUM, there is a slew of thematic and “active” ETF items obtainable to the US investor. For instance, there are ETFs that concentrate on ESG (environmental, social and governance) aspects, or on the EV/Lithium sector, or even 1 that focuses only on the pet care sector.
If SEBI requires a equivalent strategy, I consider ETFs have a extremely vibrant future in India. They will not only offer you ample chance to diversify and quick access for investors, but also lead to a lot more liquidity across the spectrum of big-, mid-, and modest-cap firms. This will in turn drive the flywheel of capital investments/innovation, development, and a lot more democratic wealth generation that propels India’s economy.
(By Atanuu Agarrwal, Co-founder, Upside AI)