Common Misconceptions About ETFs: An Indian Perspective

Exchange-Traded Funds (ETFs), one of the most valuable products created for individual investors in recent years, have gained significant traction in India. As of March 1, 2024, the Assets Under Management (AUM) of Exchange-Traded Funds (ETFs) in India has crossed Rs 1 lakh crore. This significant milestone reflects the growing popularity of ETFs among investors.

ETFs, which track indices like the Nifty 50 or Nifty Next 50, offer a simple and cost-effective way to invest in the broader market. They are passively managed and typically have lower expense ratios compared to actively managed funds. Investors who believe in the long-term prospects of the Indian economy often prefer these broad-based indices.

It’s worth noting that the ETF industry has expanded about 30 times in the past five years, starting from a relatively small base. The acceptance of ETFs by retail investors, high-net-worth individuals, and even institutions like the Employees’ Provident Fund Organization (EPFO) has contributed to this growth.

The AUM of ETFs in India has witnessed remarkable growth, reaching ₹1 trillion, and continues to be an attractive investment option for those seeking simplicity, diversification, and cost efficiency. However, despite their growing popularity, several misconceptions about ETFs persist. This article aims to debunk some of these myths and provide a clearer understanding of ETFs.

1. Myth: ETFs are More Expensive Than Mutual Funds:
Contrary to popular belief, ETFs are not necessarily more expensive than mutual funds. While it’s true that some ETFs may have higher expense ratios than some mutual funds, many ETFs offer lower expense ratios, making them a cost-effective investment option. ETFs typically have lower expense ratios due to their passive management style, which involves tracking an index rather than active stock selection.

2. Myth: All ETFs are Passively Managed:
While most ETFs are passively managed, aiming to track the performance of a benchmark index or asset, there are over 100 actively managed ETFs on the market. These ETFs are managed by fund managers who make investment decisions based on market analysis, aiming to outperform the market. Active ETFs may employ various strategies, such as sector rotation, to achieve their investment objectives.

3. Myth: ETFs Only Track Broad Market Indexes:
Many investors believe that ETFs only track broad market indexes, such as the Nifty 50 or Sensex. However, one of the top benefits of ETFs is their ability to capture the performance of niche markets, such as a single sector or sub-sector, an investment objective, or even trading strategies. There are ETFs available in India that focus on specific themes, such as technology, healthcare, or infrastructure, allowing investors to gain exposure to targeted segments of the market.

4. Myth: ETFs are Riskier Than Mutual Funds:
Since ETFs trade like stocks, there can be a misunderstanding that ETFs are riskier than mutual funds. However, ETFs can offer just as much diversification as mutual funds, as well as a wide range of choices for investors with almost any degree of risk tolerance. ETFs provide exposure to a basket of securities, spreading risk across multiple assets. Additionally, ETFs offer intra-day liquidity, enabling investors to buy and sell shares throughout the trading day, which can help manage risk.

5. Myth: ETFs are Not Good Investments for Beginners:
While ETFs are widely used by advanced investors and professional money managers, ETFs can make good investment choices for all types of investors, including beginners. ETFs offer simplicity, transparency, and flexibility, making them suitable for investors looking to build a diversified portfolio without the complexity of selecting individual stocks. Additionally, ETFs typically have lower investment minimums compared to mutual funds, allowing investors to start with smaller amounts.

As of 2024, the International Monetary Fund projects India’s GDP to grow by 5.9% in the same year. This robust growth, coupled with the increasing popularity of ETFs, presents a promising outlook for ETF investments in India. However, investors must understand the nuances of ETFs and dispel common misconceptions to make informed investment decisions.

In conclusion, ETFs offer a unique blend of the benefits of both stocks and mutual funds. They provide the flexibility and real-time trading of stocks, along with the diversification benefits of mutual funds. As the Indian economy continues to grow and evolve, ETFs are likely to play an increasingly important role in the investment landscape. By debunking common misconceptions, investors can leverage the potential of ETFs to achieve their financial goals.

The author is founder & CEO, Alice Blue. Views are personal.