1) Exchange traded funds (ETFs) provide a low-cost and tax-efficient way for investors to gain exposure to stock indices or sectors. 2) ETFs have grown tremendously in popularity globally and in India in recent decades. Global ETF assets have grown from $463 million in 1993 to over $1 trillion in 2010. 3) For financial planners, ETFs provide an opportunity to help clients invest more efficiently with small amounts of money and achieve diversification. ETFs allow comprehensive financial planning services for retail investors.

1. pAssivE invEsting
Exchange traded Funds – A route to efficient investing
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2. pAssivE invEsting
in the present scenario, with the rise of EtFs, and with its ability to provide for higher efficiencies in comparison to the traditional routes for capital
market investing, it is important for Financial planners to give it a due consideration, in line with the client needs.
Amar Ranu
Senior Manager, Third Party Products-Research
Motilal Oswal Securities Limited
T
he Efficient Market Hypothesis (EMH) explains that hedge against risk, or take a call in a particular sector, ETFs
stock markets are more efficient and less predictable. can be the best option for them. Investors can take advantage
The strong form version of the EMH states that stock of ETFs which are outlined below:
prices reflect all information relevant to the firm, including
even information available only to the key management • Cost-Effectiveness – Since there is only one transaction
or company insiders. This led to the conclusion that fund per trade, commissions are lower on an ETF as opposed
managers have been finding difficult to beat the benchmarks to an index. Absence of entry and exit loads also helps to
over a longer period as major stocks have been valued fairly keep the cost lower.
with the currently available information. So, active funds • Taxes – Capital gain taxes are generally lower for ETFs
have been losing its money in terms of increased costs. This than traditional mutual funds due to the structure.
probably led to the global fund managers to move towards • Flexibility – Like an Equity, ETFs trade throughout
a product, a fund having multiple benefits such as low costs, market hours. ETFs can be sold short or on margin, and
liquidity, fund managers’ minimum intervention, diversified prices are continuously updated during the trading day.
portfolio, tax benefits etc. Thus, the whole world moved to • Passive Management – ETFs are meant to follow a
the invention of Exchange Traded Funds, popularly known particular index, not to outperform it. Therefore it helps
as ETFs. Call its charismatic performance or its efficiency, to keep the risk and management fees for ETFs low.
ETFs emerged as the most traded shares in US surpassing the • Single Transaction – ETFs act like indexes and follow
most active stocks in terms of volume. certain market sectors. However, unlike an index, one
As per the book, Inconvenient Truths, authored by Larry can purchase an ETF with one single transaction.
E. Swedroe, it makes a strong case for passive investing and
against actively managed funds. On an average, actively- Global Journey
managed funds in US have underperformed their benchmarks ETFs have travelled a long distance since its inception
on a per-tax basis. On a post-tax basis, their returns are even in 1993 in USA. It took 7 years (from 1993 – 2000) to get
poorer. it widely accepted among investors. Once it drew attention
from investors, it grew leap and bound; the global ETF assets
What are ETFs? has reached an all time high of US $1.03 trillion as on March
Exchange Traded Funds are essentially open ended funds 2010 from an estimated US $463 million in 1993, clocking
that are listed and traded on exchanges like stocks. They a CAGR of 56 per cent. On US Exchanges, 11 out of top
enable investors to gain broad exposure to indices or defined 25 volume leaders/stocks are ETFs. Some of the top volume
underlying assets with relative ease, on a real time basis, and leader ETFs is SPDRs, iShares MSCI Brazil Index, Ultra
at a lower cost than many other forms of investing. It invests Short Russel 2000 ProShares, etc. These ETFs account for
in the constituents of the index in the same proportion as the 78 per cent of total volume out of top 25 traded stocks on US
index and come with the feel of the index. They are largely Stock Exchanges. It should be noted that the share of ETFs
passive in their investment strategy and their returns are in the total volumes was less than 25 per cent 10 years back.
more or less in line with the returns in the index. ETFs have
got a lot of benefits including low cost structure, tax efficient, Indian Journey
transparent portfolios etc. ETFs are not very old in India. It started its journey in 2001
after Benchmark AMC forayed into this unique proposition.
Why ETFs? Since then, the ETFs grew by leap and bound. The domestic
If investors are looking to diversify their investments, ETF assets grew from R 7 crore in 2001 to R 3,203 crore
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3. pAssivE invEsting
as on May 31, 2010. However, the main course of action in preferable for investors to look for a product which provide
ETFs got intensified in the recent bull period. Indian equities a decent return, at least comparable to its benchmark with
component of Global Emerging Markets ETFs account for bounty of other benefits such as tax efficiency, low expense
US $ 5.5 billion of AUM while the domestic equity ETFs ratios.
now account for US $ 0.5 billion. Overall, over the past year, ETFs are pools of stocks, bonds or in a few instances other
around 20 per cent of the net inflows into the Indian market types of investments such as Gold that you can trade like
have come from ETFs, thereby, ETFs a very significant stocks. ETFs tend to have very low annual expenses – much
component of Indian fund flows. Table 1 describes the lower than the actively managed funds. Moreover, ETFs are
holdings of major India focused ETFs listed outside India. high tax efficient i.e. they tend to minimize distributions,
which help in making the post-tax returns more efficient.
ETFs are listed on stock exchanges and can be bought and
sold like any other company share.
Product Innovations
Innovation is the key to success. At present all ETFs
are an index fund which mirrors an index or a benchmark,
unlike actively managed funds whose managers try to beat
the market. There have been talk of companies bringing out
actively managed ETFs, but so at least in India, it has not been
manufactured. Currently, in India, the underlying for ETFs
are Index, Sector, Money Market Instruments, Arbitrage etc.
In the recent times actively managed ETFs have also been
launched, which have also added to the innovations. While
passively-managed ETFs follow and mirror their index,
actively-managed ETFs follow their own fundamentally
defined rules.
Even in India, ETFs have grown by leap and bound
in last 10 years. In a surprise move, the industry has been Recent Developments in ETFs
moving towards ETFs in a more energetic way and moreover, Benchmark Mutual Fund, the pioneer in setting up ETFs
ETFs have been getting wider acceptance from all class of in India recently filed an Offer Document with Securities and
investors. Exchange Board of India (SEBI) for the launch of six open-
ended exchange traded funds. All of the planned launches
Table 2 : Total Assets under ETFs are sector-specific.
gold EtFs other EtFs
The launch of so many ETFs points to the asset
Month management company’s (AMC’s) confidence in the growing
in R Crs.
maturity of Indian investors. They are obviously of the view
31/08/2010 2639 (9) 1427 (15)
that investors now appreciate the advantages of investing via
30/06/2010 1939 (7) 1135 (14)
an index-based fund, and that passive investing might finally
30/04/2010 1711 (7) 1271 (14)
be coming of age in the country.
28/02/2010 1583 (6) 1342 (12)
31/12/2009 1352(6) 1031 (12)
ETFs-An understanding for Financial
31/10/2009 1085 (6) 868 (12)
Planners
31/08/2009 904 (6) 831 (12) ETFs provide an opportunity to investors with small corpus
30/06/2009 844 (6) 898 (12) and limited knowledge to enter the market more efficiently.
30/04/2009 717 (5) 627 (12) Historically, all the indices gave positive returns over a period
28/02/2009 781 (5) 808 (11) of time and these returns have been higher than Fixed Income
Source : AmFI, Figures in bracket represent no. of schemes
Instruments. While Gold ETFs provide a good opportunity
for taking exposures in Gold, Financial Planners must spread
Table 2 mentions of Total Assets under ETF categories the knowledge and benefits of Gold ETFs in terms of lower
in India. It shows that it has dramatically increased its figures costs, tax benefits and others. Moreover, Financial Planners
over a period of time. must stick on with the comprehensive and life-cycle financial
planning services for retail clients through ETFs.
Are ETFs good for investors?
The global historical data suggests that the fund managers amarranu@yahoo.com
have not been able to beat the benchmarks constantly over a
The author works as Senior Manager – Third Party Products Research
longer period. In efficient market scenario, the active funds with a leading financial conglomerate. Views given here are personal.
find difficulty in beating their benchmarks. So, it is always
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