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Demystifying EFTs and Passive Funds

CNBC TV18's Sumaira Abidi was joined by two experts, Mr Dheeraj Shetty, Investment Advisor, iFAST Global Markets and Mr Siddharth Srivastava, Head of ETF products at Mirae Asset Investment Managers

March 28, 2022 / 10:43 AM IST

Passive funds have garnered much popularity in recent years in the Indian mutual fund industry and are projected to rise even higher in the upcoming years. Globally too, the AUM of passive funds is climbing at a steady rate.

So how does the cost structure of a passive fund work? To discuss this, CNBC TV18's Sumaira Abidi was joined by two experts, Mr Dheeraj Shetty, Investment Advisor, iFAST Global Markets and Mr Siddharth Srivastava, Head of ETF products at Mirae Asset Investment Managers. Here are some of the insights from the discussion.

Does the Total Expense Ratio (TER) Matter while Investing in ETFs in a Passive Fund?

The total expense ratio is a cost that mutual funds, index funds and ETFs charge to the underlying investors to take care of the company's infrastructure technology and the expertise to manage these funds.

Naturally, the expense ratio reduces the return to the investor. Assuming that portfolio performance is the same, a fund with a lower Total Expense Ratio (TER) will generate more wealth for the investor.

"For a family investing 20 lakh rupees over 20 years, a one per cent difference is almost creating an asset of 1.75 crores versus 1.25 crores, that's a 50-lakh difference", Mr Dheeraj Shetty explained.

According to Mr Siddharth Srivastava, this is what makes passive funds popular. "If active funds are not able to outperform the underlying benchmark consistently, then the higher cost of active funds reduces the return to the investor, and the passive funds, which are based on the benchmark, automatically become more attractive," he stated.

What is the Cost Differential between an ETF and an Active Fund?

In terms of the expenses, ETFs have the front foot forward.

However, according to Mr Siddharth Srivastava, just because a fund is branded as an ETF, one should not assume it is cheaper than active funds. You can also find ETFs around 40 to 90 basis points. Thus, he advises investors to check the TER of ETFs to understand the cost structure.

Is There Scope in the Small-Cap and Mid-Cap Segments for Passive Funds?

Mr Dheeraj Shetty believes that it's possible to have various categories in passive funds as well. He highlighted that the mid-cap 150 index had outperformed the actively managed funds on most occasions.

Adding to this, Mr Srivastava brought to light the volatile nature of the active fund. "If you look at the last seven-year performance, 95 per cent of mid-cap funds regular plans have underperformed the mid-cap 150 index, and if you are looking at direct plans, then 71 per cent of them have underperformed the mid-cap 150 index", he shared.

He further pointed out that only four mid-cap funds have outperformed the mid-cap 150 index in three out of five calendar years. Looking at this data, he feels that the conversation should also shift towards the mid-cap category.

Can Investors Look at a Purely Passive Portfolio in the Future?

The last five years have seen a tremendous increase in index funds. With advisors and investors becoming more open and aware, Mr Dheeraj believes that many portfolios will be managed passively in the next couple of years.

Is an ETF Profitable for an AMC?

There are many products in the ETF category, from simple vanilla to exotic products. It is on the exotic products, such as smart beta-based ETFs, where AMCs earn more management fees. On the other hand, the plain vanilla side is more about increasing the investor base by bringing more investors to the passive side.

What Should Investors Consider Before Choosing an AMC?

According to both the experts, it is crucial to consider the following points before choosing an AMC:

  • Understand the index category

  • Consider the AUM size and fund management tenure

  • Track error

  • Look at the TER

The Takeaway

While passive ETFs may be cheaper and work great in a rising market, they may not be optimal for a falling market. So, investors should be careful and take a measured call between active and passive investments.

first published: Mar 28, 2022 10:17 am