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ETF is an Idea Whose Time has Come

Compared to active funds, ETFs are more transparent, says Ashishkumar Chauhan
By Malini Bhupta | December 01, 2017

Passive investment funds like ETFs are big internationally, where fund manager plays no role in managing a fund. What has led to its popularity?

Today, most funds are passive funds across the globe. If you are taking a market risk, why are you taking a fund manager risk? Stock markets have always given higher returns over a longer term, but in the 60s and 70s professors in the US came up with newer theory on efficient markets, which later went on to win Nobel Laureates. And one of the outcomes of their theory was that no fund manager can outperform the market index for very long. That theory didn’t find takers because fund managers were considered to be heroes and they ended up countering the theory that can generate alpha (or returns that are higher than the index). What is happening in India also happened in global markets. But over time, passive funds started coming into markets where the fund had stocks exactly in the same proportion as that on the Index. 

The distribution cost for mutual funds and insurance products was high even in the US back then. And index funds were traded on exchanges. You could buy index funds at any time at real-time prices. There was no worry about charges. Also, when you invest in these funds you also get dividends. The passive fund managers said they would deliver returns but they said do not deliver it to the fund management skills. It is the index which is giving you the returns. My job is to act as a clerk. This attracted people as the cost is as low as 10 basis points or 20 basis points (100 basis points make one percent). The biggest advantage was that some fund managers bought illiquid stocks and passed off very large returns. 

Vanguard launched passive funds but they were almost a pariah in the US. But the outcomes were so phenomenal that nobody could stop them from becoming the largest fund in the world. The most active fund was Fidelity but over time they had to offer passive funds. 

Is the risk lower for ETFs compared to actively managed mutual funds?

In some sense the win of the passive funds is the victory of an idea, which became larger than the hot shot fund managers. Internationally, it is proven that the Index are delivering better returns with the removal of conflict of interest and higher transparency. You can figure out your returns in real-time if the Index is at a certain level. Transparency and lower costs have made ETFs what they are. They are engines of finance globally. 

How should retail investors view ETFs now that a lot of them are being launched in India?

If India is going to do well as a concept and if an Index represents India, then at the lowest possible cost you will do well. If you believe that government enterprises will do well, you can invest in Bharat 22 ETF or if you believe IT sector will do well, then you can invest in a sectoral ETF. Most portfolios in an economy end up tracking the indices. If you are investing in Sensex, then effectively less is the cost of management and very few people have beaten it over a period of 10 years other than the greats like Warren Buffet. It is for this reason most people have gone to index funds.           

Do you see ETFs becoming popular in India?

In India, Sanjiv Shah and Rajan Mehta’s Benchmark launched India’s first exchange traded fund back in the day. They created a good framework but didn’t have the wherewithal to market themselves and finally sold it to Goldman Sachs. Reliance eventually bought Goldman Sachs asset management business in India.  Many other asset management companies launched exchange traded funds but few offered them to people as there was little incentive to make money out of it till it attains scale. Recently, when Employee Provident Funds started investing in in the market through such funds that equity funds started doing larger amounts of money.  

The government also created a PSU index. And now a new ETF has been launched by ICICI Prudential has launched Bharat ETF. Total evolution in India is at the halfway mark, but the inflexion point has come. Index funds is an idea whose time has come in India too.   

If mutual fund houses are not going to push ETFs, then do they have a future in India? 

If somebody comes and tells you that the product is going to give higher returns, and if that person is proved to be wrong again and again then what would you do? On the other hand there is a product that nobody tells you will do better, but is proved to deliver better returns then slowly you will disbelieve the person who is selling you the product. This is investment by induction and seeing other people do it, over time people will look at returns and costs.  For instance, Bharat 22 will have less than 1 basis point as cost in a year. When markets become institutions oriented, they don’t want to take a fund manager risk. The index funds give them low cost funds and transparency. No amount of marketing can stop ETFs from becoming popular. 

Asset management companies are not going to push these products as they are very low on cost. So, how will this product ever get popularised?

Market regulator SEBI is doing a lot of things to popularise index funds. Fund advisors cannot be distributors according to regulation. If an independent financial advisor is advising you on asset allocation, then the person should encourage you to invest in ETFs. SEBI has come up with several reforms to ensure that the investors are protected. Slowly when they are fully enforced, the person advising you will charge you. The push of reforms is coming from regulators. 

 

Ashishkumar Chauhan
MD & CEO, BSE

 

 

malini@outlookindia.com

 

   

 

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