100 ETFs: Time for celebration and caution

India celebrated its 100th ETF listed on NSE this week. It took 19 years to get there with over a fifth of these funds added in the last one year alone. Industry insiders say there is likely to be further action in the space of passive investing. And why not? ETFs have their own inherent merits for investors that other categories of mutual funds do not offer. They are cheaper (lower expense ratio); offer trading flexibility much like stocks; and can be bought for small ticket sizes. They can be traded during market hours giving investors the option of making the most of daily gains in indices, while enjoying the benefits of mutual fund units (not stocks) being held in their demat accounts.

Traditional mutual funds, on the other hand, are more expensive and rigid. Moreover, ETFs being pegged to an index makes them easy for an investor to track, understand and act on.

In an earlier edit on June 19th, Money9 argued that passive investing must be considered actively by investors.

Read Here | Get active on passive investing

Passive investing should be part of the investor’s portfolio, but not all of it. Professionally formulated asset allocation will see an investor through both good times and bad. Only passive funds would not. Here is why.

While ETFs offer a cost-efficient and easy entry point, investor caution must be exercised. For one, the investor is at the mercy of the stocks comprising the ETF and their performance – not the acumen of a fund manager who strives to beat the index. In ETFs, there is no active fund manager to rebalance the ETF composition basis news triggers. The fund mirrors the index.

For example, a Nifty 50 ETF – the most popular ETF category in India – will always consist of the 50 largest listed companies in India. No ifs and buts. No room for the addition or subtraction of stocks that may drag the index in a market cycle. The index rebalancing is done by the exchange basis valuation alone.

In ETFs or even index funds, the downside is unlimited as these are 100% equity with no debt in the allocation. The upside is also limited only to that of the index it tracks.

As markets remain bullish and indices command new highs, ETFs look like a great option. But nothing lasts forever.