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(Photo: iStock)
(Photo: iStock)

Index ETFs fail to track indices as market makers stay away

  • Market makers faced liquidity troubles in their other positions in a volatile market
  • Market makers (usually brokers) are entities that buy and sell ETF units, making money by charging a small spread between their buy and sell prices

Mumbai: As the Nifty crumbled by 7.61% on 16th March, Exchange Traded Funds (ETFs) tracking it failed to keep up. Nippon India ETF Nifty BEES, one of the largest and oldest ETFs tracking the Index fell by just 2.23%. SBI ETF Nifty 50, which has assets under management of 64,464 crore, and is India’s largest equity mutual fund scheme, closed up instead of down. It closed with a gain of 1.16%. The tracking failure was not just limited to the Nifty. SBI Sensex ETF was down 3.61% even as the Sensex itself fell by 7.96%. Intra-day moves in the ETFs tracking India’s benchmark indices were also wildly out of sync with the underlying indices. This may have hurt retail investors trying to take advantage of the market correction.

An ETF is a passive mutual fund. Its aim is to simply give the same returns as the index it is tracking such as the Sensex or the Nifty. It does not seek to outperform and hence has a low expense ratio. A fund manager at one of India’s largest ETF providers told Mint on condition of anonymity that there were three reasons for this failure of ETFs to track benchmark indices. First, he said market makers faced liquidity troubles in their other positions in a volatile market. Market makers (usually brokers) are entities that buy and sell ETF units, making money by charging a small spread between their buy and sell prices. Their activity ensures that an ETF’s price trades close to its Net Asset Value (NAV). Second, he said that the government lock-in on Yes Bank shares put off market makers. Yes Bank occupies a mere 0.2% weight in the Nifty, but this is enough to wipe out the thin margins that market makers operate on. Third, there were fears about circuit limits being triggered due to sharp falls and hence trading being halted. Circuit limits are percentage boundaries laid down by exchanges to pause trading in case of steep falls.

Anubhav Srivastava, Partner and Fund Manager, Infinity Alternatives noted that the ETFs were traded at a premium rather than a discount to the indices. “There could be several explanations. With market makers not active, retail investors could have driven up the price. Alternatively, it could be a market participant that wants a high last traded price to make its books look good," he said.

The ETF out-of-sync behaviour would have hit both retail investors buying directly and those buying baskets of ETFs through platforms, a concept popularised by fintech companies such as Smallcase. “People investing in thematic baskets of ETFs may not have even realised what has happened. The basket NAV is one step removed from the underlying ETFs and many investors would not have doubled checked the underlying," said Gaurav Rastogi, CEO, Kuvera, a mutual fund investment platform. For retail investors, the lesson seems to be - buy index funds over ETFs. Index Funds are bought and sold at their Net Asset Value (NAV) from a fund house and hence the danger of buying the fund at a steep premium is ruled out.

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