Why investors prefer active funds over ETFs

For an outsider, the stock markets can be a bewildering place. Equity indices have been swinging wildly, with the relentless rise of last year now being countered with wide fluctuations. So, should a stock market investor blindly follow the index? One way of measuring this is through index ETFs (exchange-traded funds), promoted by mutual fund companies.

Unlike a fund unit, an index ETF can be bought and sold through an exchange anytime through market trading hours, very much like a share, and at much lower costs than a full-fledged fund. But it is a passively managed product, which means the fund manager only imitates the index’s stock holding in order to match its returns.

In developed markets, where it is more difficult to outperform a benchmark index, ETFs are more popular than regular funds. But is this slowly becoming the case in India as well?

The fund industry has mixed views about this. On the one hand, SBI, Reliance and ICICI asset management companies have filed documents with the regulator to launch ETFs. But the ETFs already in the market are asset-poor, with one even set to shut down soon.

According to India Infoline, investors here believe actively-managed funds will give them better returns, which is why it plans to wind up its Nifty ETF. R Venkataraman, Managing Director, IIFL, said their ETF asset size has been dwindling. “From ₹40-50 crore at its peak, we are now at ₹6 crore, despite being among the cheapest ETF options (expense ratio of 25 basis points) in the market.” IIFL’s Nifty ETF holders will have the option of either exiting or merging their units with the large-cap growth fund.

Contrast this with rival AMC Edelweiss, which in April launched its own Nifty ETF, and foresees increasing demand for the product, particularly among institutional investors.

This bears out with data as well. According to the Association of Mutual Funds in India, the assets in non-gold ETFs for March 2015 have risen nearly 78 per cent from March last year. But within this, retail investors have contributed less in terms of assets over the same period (from nearly 11 per cent to just over 8 per cent), through marginally fewer folios, while institutional investors (domestic and foreign) have gained dominance.

Vinay Agrawal, CEO, Angel Broking, said ETFs can still do find customers, but only those agreeable to index-based returns at low costs. “Buying a large-cap fund entails larger management fees and it’s all a matter of chance. At the end of the day, you don’t know if you will beat the benchmark.”

Mahesh R Patil, co-Chief Investment Officer, Birla Sun Life Asset Management, admits that no big money has yet come into ETF products. Birla’s own Nifty ETF has assets of about ₹2 crore, compared to the ₹8,733 crore in their flagship Frontline Equity Fund.

“Globally, ETFs are popular because over half of all active fund managers aren’t able to beat their benchmarks. In India, well-managed funds have consistently beaten their benchmarks. So the bulk of investor money is still directed to these products. At Birla, our ETF is just a platform meant for the future when beating the benchmark will become more difficult.”

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