Mumbai: Amid the global economic uncertainty that has made investment more of a gamble than ever, exchange-traded funds (ETFs) have held their own, while offering an avenue of entry for foreign investors to India that the regulator regards with approval.
An ETF is a listed security that tracks an index, a commodity or a basket of assets such as an index fund, but trades like a stock on an exchange. ETF prices change through the day as they are bought and sold. They are regarded as providing the diversification of an index fund with the flexibility of a stock.
India’s capital markets regulator, the Securities and Exchange Board of India (Sebi), clears ETFs faster than it does other funds. ETF assets in India continue to increase while foreign investors are offloading stakes in all other asset classes. This is persuading both foreign and domestic fund houses to start ETFs in India.
This year the regulator has cleared at least 21 ETFs run by foreign fund managers, compared with five in 2010, four in 2009, five in 2008, and six in 2007.
“In fact, the regulator has clearly indicated that it’s more comfortable with broad-based foreign money (coming in through ETFs) as the identities of the investors are clearly indicated,” said Naveen Kumar, managing director, INDXX Capital Management Services Pvt. Ltd, which has started four ETFs with allocations in India.
Broad-based funds are those with a large number of clearly identifiable investors, unlike other foreign funds over which Sebi has occasionally expressed concern.
“ETFs mostly bring in retail money to invest in stocks or indices listed on the exchanges. So, the money coming through ETFs is more transparent in nature,” Kumar said.
While the segment is relatively new in India, global ETF assets are worth at least $21.05 trillion (Rs 1,040 trillion). There are 34 global ETFs with an exposure to the country, including eight India-dedicated funds, with overall assets of at least $72 billion.
“We see growth and plan to launch three more ETFs with India exposure in the next one year,” Kumar said.
Domestic fund houses, including Birla Sun Life Mutual Fund and Kotak Mutual Fund, are also keen on starting ETFs.
“As one of the asset classes, we will look at ETFs,” said A. Balasubramanian, chief executive of Birla Sun Life Asset Management Co. Ltd, which managed assets worth Rs 67,475.15 crore as of 30 June.
Most ETFs started by Indian fund houses are based on gold and the National Stock Exchange of India’s 50-share index Nifty. That is likely to change as the market matures.
Kotak Mahindra Asset Management Co. Ltd, which manages Rs 33,993.54 crore of assets, has three ETFs excluding gold, according to chief executive Sandesh Kirkire.
“We have some more of the sort on our drawing board,” Kirkire said. “As markets deepen you will find more ETFs coming in.”
Global ETFs with exposure in India invested $2.57 billion locally in the July-September period, according to INDXX Capital. During the period, equities witnessed a net outflow of $13.92 million, and debt assets saw inflows of $1.41 billion by foreign institutional investors (FIIs).
As investors globally migrate to safer asset classes, FIIs are offloading their direct stock investments in emerging economies, including India. In contrast, money continues to flow into ETFs in the country.
India-dedicated ETFs mostly invest in the Nifty. INDXX Capital calculated that, given a base of 1,000, an ETF based on the Nifty would have grown at 12.5% since February 2010 against an advance of 3.3% by the index.
While India’s benchmark equity indices are trading at least 20% down from their year-opening levels, assets under the eight India-dedicated foreign ETFs remain almost constant at around $3 billion for the year, indicating incremental investments into these funds. Assets under India-dedicated ETFs have grown exponentially from $172 million in January 2007 to $3 billion by July end.
Since January 2010, there have been no net ETF outflows from India, unlike domestic equities. INDXX Capital estimates the total assets under ETFs with India exposure at close to $5 billion and this is expected to grow in the coming years.
“ETFs constitute nearly 7% of the total FII assets in India and by next year this should go up to 9-10%, considering other factors (are) constant,” said Kumar.
There are 29 ETFs currently traded on the National Stock Exchange (NSE).
“As financial literacy improves, you will find higher allocation to such asset classes,” said Kirkire.
While global ETF managers want to enhance their India exposure, the country currently does not have too many underlying assets on which they can be based.
“In countries like India, where the index fund category is not comprehensive enough, investors might not be able to take specific sector or market segment exposure, a choice that is available on the actively managed side,” said Harshendu Bindal, president, Franklin Templeton Investments India Pvt. Ltd, which manages Rs 34,729.35 crore in mutual funds. That should change.
Asia’s oldest bourse, BSE Ltd, has a number of indices that ETFs could be based on.
Sebi is to keen to approve BSE’s application to get the indices approved for global ETFs to encourage competition among the exchanges, said a person with direct knowledge of the discussions between BSE and Sebi.
Apart from the six broad BSE indices based on market cap, there are 13 sectoral ones based on different industries.
“There has been a growing interest in launching ETFs on the BSE platform, more so after the relaunch of Sensex futures,” said a BSE official who didn’t want to be named. “Several foreign and domestic mutual fund houses have approached us to launch index-based ETFs and we are in talks with them.”
The regulator didn’t respond to queries.
ETFs also have lower expense ratios than those of the average mutual fund.
The expense ratio ranges from 0.35% to 1% (0.75% to 1.5% in the case of index funds, while actively managed funds charge up to 2.5% of the corpus) “as they are not necessarily requiring the service of fund managers and analysts,” HDFC Securities said in a June 2011 report.
India Infoline Ltd recently debuted in the mutual fund business with the introduction of an S&P CNX Nifty linked ETF in which all fees and expenses were capped at 0.25%.
The average expense ratio for ETFs, including gold schemes on 30 April, was 0.84%, the report said. That compares with 2.5% for most other mutual fund schemes. For monthly instalment plans, the expense ratio is typically 1.7%.
“The advantage is definitely the cost structure that attracts informed retail investors and institutional investors,” said Jaideep Bhattacharya, chief marketing officer, UTI Asset Management Co. Ltd, which manages assets worth Rs 69,105.09 crore. “However, many investors who may want to invest in ETFs may not have demat accounts and that is a major hindrance.”