Investors must have low-cost passive products like ETFs and Index Funds in their portfolio: Vishal Jain

In both ETFs and Index Funds one must choose those with low Tracking Error and Expense Ratio. In ETFs investors must additionally look at the liquidity before investing, Vishal Jain, Head, Nippon India ETF said in an interview to Money9.

In the last one year the numbers of ETF investors and ETF volumes have gone up. What do you think are the reasons and what are the benefits of investing in ETFs?

Volumes in ETFs have definitely increased manifold in the last 1 year. Investors have begun to accept and understand the benefits of ETFs namely their low-cost nature, diversification at one shot, and real-time pricing. Also, the sheer ease and simplicity with which one can build a meaningful asset allocation mix is the highlight. For e.g., if one combines a Nifty and NiftyNext50 ETF, one can easily build a portfolio of the top 100 large-cap companies in India. One can also combine low correlated indices to construct portfolios using equity, fixed income and commodity ETFs. The plug and play nature of ETFs is an appealing factor for investors.

ETFs worked well when markets bounced back from the lows recently. Do ETFs still remain attractive or will actively managed funds be a better choice for investors at this point?

ETFs work well in all market conditions. Market index rate of return is the only assured return going forward. It is advisable to do a Core-Satellite asset allocation between ETFs and active funds in order to benefit from both Beta and Alpha. Beta will eliminate non-systemic risks such as stock and manager selection. In addition, the low-cost nature of an ETF will add to overall investor return over long periods of time.

ETF schemes often suffer from illiquidity. How should investors handle this situation? Is a fund of funds investing in units of an ETF the only solution?

There are three important factors that investors must look at while investing in ETFs – liquidity, expense ratio and tracking error. There will always be some ETFs that are more liquid than others and therefore it is advisable to pick those ETFs with higher liquidity. Generally, it has been seen globally and in India that diversified ETFs attract larger liquidity compared to thematic or sectors. In any ETF, there are market makers that provide liquidity and therefore the best way to trade them is to look at the “Indicative NAV” disclosed on the website of the AMC and place limit orders around that.
Fund of Fund is a good option if one is not able to replicate the underlying index due to any reasons. Else ETF or Index Fund is preferable.

How many Index Funds do you have in your bouquet and which new products are you planning to launch in this direction?

At Nippon India Mutual Fund, we presently have 5 Index Funds and 2 Fund of Funds across equity and gold. We constantly evaluate and launch products based on market feedback and investor interest. We already have the largest suite of ETFs and will keep adding logical building blocks as required. Additionally, we are now looking at increasing our bouquet in Index Funds across equity, debt and international exposures.

What should investors looking for passive funds opt for – ETFs or index funds? Which one is suitable?

It’s important for investors to add low-cost passive products to their portfolio. It does not really matter in which format one subscribes, through ETF or Index Fund. If investors possess a broking and demat account and regularly access the stock markets they can look at investing through an ETF. Investors who prefer the normal mutual fund structure or the ease of doing a regular SIP can look at investing through Index Funds. In both ETFs and Index Funds one must choose those with low Tracking Error and Expense Ratio. In ETFs, additionally, investors must look at the liquidity before investing.

What is your view on the market from here on? With the huge run up what would be your broad suggestion to equity investors?

More than timing, it’s important for investors to follow the right asset allocation mix. Academic research, specifically the Brinson, Hood, Beebower study done in 1986 on large pension funds, demonstrated that a significant component of portfolio return (nearly 88 to 90%) was a result of asset allocation. Only a small part of portfolio return accrued on account of selecting individual securities and market timing. Strategic diversification across asset categories becomes necessary in order to reduce overall portfolio risk and the easiest way for investors to diversify across asset categories is through ETFs.