Exchange Traded Funds — Simplified. ETFs can be part of your core allocation for the long term: Chintan Haria

As an investor looking for new investment avenues, you would probably be aware of, or at least heard of, exchange traded funds (ETFs) — thanks to the popularity of gold ETFs in India. But gold ETFs aren’t the only one. There are equity ETFs, bond ETFs, liquid ETFs and thematic ETFs based on consumption, infrastructure etc.

So, where should a new investor begin? What is the investment time horizon for ETFs? Can an investor substitute an active index fund with an ETF? What portion of your portfolio should be allocated towards ETFs? These are some of the questions that may weigh on your mind before you embark upon your investment journey.

“Index funds are essentially those mutual funds which track a particular index. An ETF is simply a mutual fund which follows a particular index and is listed in the stock exchange for investors to participate on a real time NAV basis,” said Chintan Haria, Head, Product Development & Strategy, ICICI Prudential Mutual Fund.

He was speaking at a webinar, ‘Exchange Traded Funds (ETFs) — Simplified’ presented by ICICI Prudential Mutual Fund and BusinessLine on Saturday. The webinar was moderated by Radhika Merwin, Associate Editor, BusinessLine .

However, Haria also highlighted that while ETFs are essentially mutual funds traded in the exchanges, they should be fully considered as a trading vehicle or part of a trading portfolio. “In fact, ETFs can be part of your core allocation for the long term in terms of wealth creation through equity ETFs.”

He also added that the liquidity on the ETF exchange has improved significantly over the last three-four years as more and more investors are entering the market due to increasing awareness about the product.

On the choice between active investments like equity mutual funds and ETFs, Haria said that in a true sense, an ideal investment portfolio should have a good mix of active and passive funds to manage different market cycles over a period of time.

Types of ETF

On the category of ETFs available for investment, Haria said: “We have seen a lot of ETF additions over the last two-and-a-half years. In addition to traditional large cap ETFs, we now have mid-cap ETFs. Although we don’t yet have small cap ETFs, we do have index funds around small caps.”

He added that investors could also look at thematic ETFs which invest in specific sectors such as banks and IT, among others.

However, he also pointed out that an investor should not look at ETFs as a substitution for each of their active funds but from a holistic portfolio balance perspective.

Portfolio allocation

“For instance, if you want 50 per cent of your portfolio in large-cap based funds, you can plan to have 40 per cent in active and 10 per cent in passive (ETFs) because everything has a cycle. Today, ETFs or indexed funds are performing better because of the cycle, but it is not necessary that this cycle continues forever,” Haria said.

For choosing the right ETF, Haria said, investors can consider the expense ratio and liquidity of ETFs (whether they are easy to buy or sell in exchange) to determine the right fund, while financially savvy investors could also look at the ‘tracking error’, which is based on complicated statistical calculations.

“But I think selection of a particular ETF category and staying invested for the long run matters more than essentially which of these parameters you tick-box and then select an ETF,” he added.

On the investment time horizon, Haria said ETFs or any other equity investments, it is optimal to stay invested for a minimum of three years but holding it for a longer period can offer the benefit of long-term economic cycle.

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