Lately, the buzz on exchange-traded funds (ETFs) has been getting louder on Dalal Street. The latest is that the Government is actively considering launching an ETF consisting of 11 Central Public Sector Enterprises within a month. The Government wants to raise about Rs 3,000 crore through the CPSE-ETFs.

Chitra Ramakrishna, Managing Director & Chief Executive, National Stock Exchange, has also asked stock brokers to actively push ETF products to retail clients.

ETF is a security that tracks an index, a commodity or a basket of assets like an index fund, but trades like a stock on an exchange.

ETFs allow long-term investors to diversify their portfolios and insulate them from short-term trading volatility. They also provide liquidity to investors with a shorter-term horizon as they can trade intra-day and can benefit from near-NAV quotes during the course of the trading day.

ETFs came into existence in India in 2001 when Benchmark Mutual Fund (now taken over by Goldman Sachs) launched its first ETF on Nifty. But even after over a decade of existence, the penetration of ETFs among investors continues to remain lukewarm. Just 36 ETF schemes have been launched since the first hit the market.

Of these, most are gold ETFs. During the October-December quarter, gold ETFs accounted for assets worth about Rs 8,500 crore and non-Gold ETFs Rs 1,500 crore. Compared to that, the average assets under management (AUM) for the entire mutual fund industry during the same period stood at Rs 8.76 lakh crore.

So, what ails the ETF industry in India?

The foremost reason is the lack of awareness about ETFs. Even those who are aware of ETFs, prefer actively-managed funds to investing in passive funds such as these. The general notion is that actively-managed schemes will always outperform passively-managed index funds.

In fact, a look at the performance of actively-managed schemes viz-a-viz passively-managed ones, validates this view. And this is more so, during periods of market volatility.

At least to create awareness, SEBI could reconsider a fee-based asset allocation driven investment culture, which was allowed in India till 2009. In developed countries, such as the US, awareness and investment are vibrant, thanks to fee-based independent financial advisers.

Similarly, Australia and the UK allowed fee-based advice, which resulted in a huge uptake in ETF assets.

Until 2009, mutual funds thrived on the salesmanship of independent distributors, who pocketed a commission on sales. This commission was paid by the funds out of an entry fee charged to new investors. In 2009, SEBI banned this entry load, which significantly affected the sales of mutual funds.

However, SEBI in 2012 relaxed the rule and allowed incentives to distributors to sell mutual funds, but outside the top 15 cities.

But even that has proved inadequate. More needs to be done – the rule could altogether be done away with.

Finally, one segment of investors who could give ETFs the decisive big push are the traders – arbitrageurs, hedge funds and institutions, who keep premiums and discounts very tight. They can help ETFs finally make their mark in the markets – more than a decade after their entry.

badrinarayanan.ks@thehindu.co.in

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