Well, we have a recent example. Pakistan was the underdog but won the Champions Trophy 2017! And investing, just like cricket can be a funny game.
But let’s not digress from the topic, the ETFs. Let’s try to understand what ETFs are and try to figure out why it can be a winning investment for you.
Before we start, here’s an example for you to ponder over. Vanguard S&P 500 ETF is an ETF in the US which manages a fund of $324.6 Billion. In Rupee terms, it’s more than Rs 20.5 lakh crores. And to put it in perspective, the entire assets managed by the mutual fund industry is hovering around Rs 20 lakh crores!!
So let’s dig in to understand this wonder investment called ETF.
ETF stands for Exchange Traded Funds. You can buy and sell an ETF on the stock exchange like any other stock. But when you buy an ETF, you are not buying an individual stock like HDFC, Asian Paints, L&T, etc. You are buying the entire basket of stocks.
Here’s my favorite analogy. You know the story when Lord Hanumaan was asked to pick up Sanjivani Booti (Herb) from the mountains, he had difficulty identifying the right herb. So he picked up the entire mountain and came back. Similarly, if we have difficulty in picking the right stocks, we can as well pick the entire basket/market!!
And when you buy an ETF, you need not pay fund management charges and your portfolio is automatically diversified.
Sounds good? But you may be wondering why ETFs are not really popular in India, right? Let’s find out.
First off, there’s the issue of distributors selling the ETFs. With low margins, the distributors are not motivated enough to sell ETFs. And financial products are basically pushed products, they are not bought on their own.
Secondly, since there are not enough ETF holders, there’s the problem of liquidity. Since it is traded on the stock exchange, you have to find buyers before you can sell and vice versa.
Thirdly, many actively managed mutual funds have over-performed the index. Though again, getting the right mutual fund scheme is another selection headache, this is one reason the distributors tell investors to discourage ETF investments.
Having figured out the reasons why ETFs are the underdogs, here’s why they can be a winning investment.
- ETFs are low cost. The expense ratio in India ranges from 0.20% to 0.80%. In the US it’s 0.04% because there are a large number of investors. So as the number of investors in ETFs grow in India, the cost will also come down.
- ETFs are automatically diversified.
- ETFs hedge the risk of stock selection or the fund managers’ risk.
- As the markets evolve in India and become more transparent, generating alpha or over-performing the index would be more and more difficult. As they say, past performance is not an indicator of future performance. So ETFs will give the optimal returns in the future.
- There are tax advantages for first-time investors under Rajiv Gandhi Equity Saving Scheme for ETF investors.
I have no hesitation in saying that ETFs will be the winning investments of the future.
Do share your questions and comments about ETFs.