life in financial markets: ETFs in India

Exchange traded funds (ETFs) are not very popular in the Indian financial marketplace for all the wrong reasons (such as 'fancy for active stock picking based on hot tips or herd mentality investing'). Internationally, they are a big hit but some risks (such as 'low liquidity due to absence of arbitrageurs (that may be on account of very low unit capital of the ETF') are not carefully considered

Anyway, here is something I wrote on ETFs two months ago for the magazine I worked for then:

The promise of ETFs

Very popular internationally, ETFs have not caught the imagination of Indian investors. But they should.

Last year was not a good year for index funds and index exchange traded funds (ETFs) in the domestic mutual fund industry, but only with regard to assets under management (AUM). The combined AUM of 8 ETFs as on 31 December 2009 was Rs 932 crore, just 0.8% of total AUM in non-index equity schemes of Rs 1,96,946 crore. This was an exceptionally low figure as in previous two years, for December-end 2007 and December-end 2008, their proportions were 4.1% (Rs 6,064 crore) and 2.1% (Rs 1,504 crore) respectively.

But, whether vastly popular or not, as it is in many western markets such as US and UK, passive investing has come to stay in India. The lack of high growth in index products is due to reasons such as lack of awareness and perception of deriving more returns from actively-managed equity funds. "But indexing is what someone should definitely be doing," says Gaurav Mashruwala, a leading certified financial planner (CFP). "We advise investors to start with index ETFs."

But differing perceptions hold forth. Says Nilakshi Louzade, a CFP and a partner in financial planning firm, InTrust Advisors, "Index ETF buyers presently comprise of first time investors or very small retail investors but since a large part of our listed companies' growth is coming from companies outside the Nifty or Sensex we do not advise large allocations to index ETFs or funds."

Empirical studies, however, bring out the overall underperformance of actively-managed funds against passive index ETFs. Benchmark Asset Management, the pioneer in ETFs in the domestic fund industry, carried out two such studies in 2009, in May and in December, that confirmed this.

The December 2009 study analysed, for 57 diversified actively-managed equity funds with a 3-year track record as of December 2006, their average rolling 3-year NAV performance (percentage change in the NAV of a given date from the NAV of the same date exactly 3 years ago) from December 2006 to December 2009. This was compared to the corresponding 3-year NAV performance of Benchmark's Nifty ETF.

The 57 active funds, on an average, gave absolute returns that were worse than the Nifty ETF by between 2% and 6% from December 2007 to December 2009. An absolute underperformance of 6% meant that if the ETF was giving a 3-year return of 10% then the 57 funds were giving a return of just 4%, and if the former was a negative 10% then the latter was a negative 16%.

Among index products, index ETFs have got more attractive than index funds. Every time you purchase units of an open-ended index fund the amount gets invested in all the index stocks in the proportion of their weights, but when you buy the NSE-or BSE-traded units of an index ETF the corpus does not change as it an existing ETF unit-holder who is selling the units. In addition to the convenience of holding ETF units in the investor's demat account, this keeps the transactions cost low.

Almost all index ETFs have an annual management expense charge of 0.5% whereas the index funds charge between 0.8% and 1.5% per annum. Index ETFs' tracking error is the lowest. So, for instance, from December 2007 to December 2009, when the spot Nifty delivered a negative return of 12.79%, the Benchmark Nifty ETF gave a negative return of 12.41% and three Nifty Index Funds—of Franklin Templeton India AMC, Unit Trust of India AMC and LIC AMC—gave higher negative returns of 13.49%, 14.10% and 19.56% respectively (see graph).

ETFs hold the promise of providing easy and long-term exposure to different asset classes. Gold ETFs are already a hit in the domestic fund industry (see story on gold in this issue). Benchmark's Liquid ETF offers an easy way to get the same exposure as you would from a liquid fund of any AMC.

The western markets already have ETFs on other asset classes such as currencies and commodities and within equities on sectoral indices such as those tracking clean energy stocks and real estate stocks. Some of these are likely to hit the domestic scene in the coming year or two. For instance, Benchmark AMC has filed offer documents with Sebi in 2008 to launch ETFs on crude oil, silver and government securities and fund of equity ETFs covering the themes of clean energy, private equity and water.

The scope is exciting. Keep the faith and patience.

life in financial markets: it kicks off at last. a global equity product on nse

In my 19Aug09 blogpost I had broken the news of how NSE was very close to introducing a global equity product on its domestic trading platform.

Well, the news has broken now. Read below yesterday's (Wednesday, 10 March 2010) joint press press release of NSE and CME (Chicago Mercantile Exchange). It talks about NSE being licensed the use of S&P 500 index and Dow Jones Industrial Average index in futures contracts (only, options contracts not yet) on the two indices in its equity derivatives trading segment, and NSE's Nifty index being licensed to CME to use in futures (only, options contracts not yet) contracts in CME's equity derivatives trading segment.

So, Indian investors will be able trade in futures (but not options) on S&P 500 and DJIA and American investors will be able to traded in futures on Nifty index.

Although the new products are welcome I am disappointed that it is the only two. I would love to trade through a NSE broker on the NSE trading platform international ETFs (exchange traded funds), particularly the ones on green energy. NSE needs to tie up with other index providers and exchanges where those ETFs are listed and traded.

The CME-NSE press release:

Stock Exchange of India (NSE), the largest stock exchange in India, and CME Group, the world's leading and most diverse derivatives marketplace, today announced cross-listing arrangements, including license agreements covering benchmark indexes for U.S. and Indian equities. The parties have also entered into a Memorandum of Understanding with respect to other areas of potential cooperation, including related to development and distribution of financial products and services.
Under the cross-listing arrangements, the S&P CNX Nifty Index (the Nifty 50), the leading Indian benchmark index for large companies accounting for 22 sectors of the Indian economy, will be made available to Chicago Mercantile Exchange (CME), for the creation and listing of U.S. dollar denominated futures contracts for trading on CME, and the rights to the S&P 500® and Dow Jones Industrial Average™ (DJIA®) will also be made available to NSE for the creation and (subject to regulatory approval) listing of Rupee-denominated futures contracts for trading on NSE. The license to the Nifty 50 from NSE's affiliate India Index Services & Products Ltd. (IISL), which is exclusive to CME Group within the Americas and Europe, is in addition to the existing licensing arrangement between Singapore Exchange Ltd. (SGX) and IISL. The sublicenses to the S&P 500 and DJIA indexes, which are exclusive to NSE for Rupee-denominated futures contracts traded within India, are being made available via sublicenses from CME Group and each of Standard & Poor's and Dow Jones, respectively.
"Indian financial markets have gone through a phase of rapid growth in the past few years," said Ravi Narain, MD & CEO, NSE. "Our products are traded by institutional investors worldwide, making the Nifty 50 one of the more widely traded global products. This association with CME Group will make the Nifty 50, and, over time, potentially other products across various India-related asset classes, available to a much larger community of traders and investors. At the same time, investors in India will have access to new exchange traded products that reflect some of the world's most widely traded equity indexes. This will improve portfolio choice for Indian investors by widening the array of assets that they can hold in their portfolios."
"These agreements with NSE, India's largest stock exchange, represent another example of CME Group's commitment to expand our global offerings and services to our customers," said Terry Duffy, Executive Chairman, CME Group. "These arrangements will allow us to expand on our benchmark equity index product suite and provide our customers with access to a futures contract that is based upon the leading benchmark index reflecting the Indian equity markets."
"Our new partnership with NSE is an integral part of our global growth strategy," said Craig Donohue, Chief Executive Officer, CME Group. "In addition to our existing partnerships or investments in Brazil, Dubai, Korea, Malaysia, Mexico and Singapore, our NSE partnership will further expand our customers' access to the most actively-traded foreign markets, while also increasing access for global investors from within these regions to CME Group products and services. As the world's 12th largest and one of the most rapidly growing economies, India is an important part of our efforts to develop strategic partners in key growth markets."
"We see this as a very exciting development that marks the coming of age of Indian financial markets," added Mr. Narain. "This will go a long way in achieving our vision of supporting economic growth in the country by making Indian financial products available globally and meeting the needs of our investor community for global products."
"S&P Indices has a successful, twenty-seven year relationship with the CME Group in the U.S. futures market, and a strong ten year association with the NSE in developing stock market indices in India," says Alexander Matturri, Executive Managing Director at S&P Indices. "We are certainly pleased to be working with both of our longtime exchange partners to help Indian investors gain greater access to the U.S. equity markets as determined by the S&P 500, an index with nearly $1 trillion directly indexed to it."

life in financial markets: coming soon -- a global equity-based product on the NSE?

Today, if an Indian small individual investor, such as me, wants to invest in global ETFs and securities I hardly have much option other than go through icicidirect.com (which is the only one that does not demand a minimum Rs 5 lakh worth of initial global investments) and 3-4 others like Kotak Securities, India Infoline etc. Even with them one has to convert Rs into Dollars and transmit the same to the international dollar account before executing trades on NYSE or any other exchange. The whole process is very cumbersome, time consuming and costly.

Shouldn't, therefore, an efficient stock exchange such as the National Stock Exchange of India (NSE) list on itself ETFs (exchange traded funds) and/or equity-based securities/funds that are based on indices or securities from outside India (and run/managed by international ETF providers) or that are already listed on exchanges elsewhere outside India? This will make it possible for an investor like to me to buy or sell the global ETF/security right here in India and settle the trade on NSE in rupees. Its unfortunate but the NSE has been delayed in doing something about it despite having NYSE-Euronext as one of its shareholders (holding 5% stake).

Well, a little bird tells me that the NSE, indeed, is in the final stages of launching such a global ETF/product and an announcement is likely to be made within a week or month. As an investor, I hope I am not disappointed by the choice of the global ETF that NSE initially brings to India. I would also prefer to see a robust range of global products listed and traded on the NSE. I am particularly very bullish on alternative energy ETFs listed and traded on stock exchanges in US, UK, Singapore etc.

Lets see what NSE gets here.


UPDATE (11 MARCH 2010): The global product has finally come. Read my 11 March 2010 blogpost

life in financial markets: invest in green ETFs

The next 5-30 years is going to be the best years for green energy companies and if you are an investor in global markets having access to global exchange-traded-funds listed on exchanges such as NYSE-Euronext and London Stock Exchange then I would strongly encourage you to go out and there and buy green or alternate energy ETFs.

You could invest once every month in one or more of these ETFs. After accumulating about 10-15 such ETFs you could add to these ETFs plus occasionally keep picking up other or new ETFs in the field of green energy.

I know of at least two such ETFs that can be immediately invested in. The first is Van Eck Global Alternate Energy that is listed on NYSE-Arca and designed to mimick the Global Ardour Index. The second one is ETFS DAXglobal Alternative Energy Fund that is listed on London Stock Exchange and designed to mimick the Daxglobal Alternative Energy Index.

Even investors in India should invest in these rather than putting their money in environmentally and socially unfriendly companies such as Reliance Industries, other Reliance companies, DLF, Unitech, pharma companies, Sterlite, Sesa Goa and pesticide-manufacturing companies.