Low expenses ensure that such passive funds don't disappoint investors

John C Bogle, the US born legendary mutual fund veteran always insisted on bringing down the costs of fund management for the simple reason that any savings on costs by the mutual fund scheme that you have put your money in would add to the corpus. And in the long run, this could make a substantial difference to the total corpus you accumulate compared to what you would have got if the costs were higher.

The result of such a logic was the launch of exchange traded index funds, popularly known as exchange traded funds (ETFs), although late ly other types of ETFs have also been launched in the market with varied degrees of success.

ETFs are usually passively managed funds, meaning these funds track some bench mark index or the price of some physical or financial as sets and, unlike regular mutual funds, do not try to out perform their benchmark index by regularly buying-selling the portfolio of stocks.

So, ETFs naturally come with much lower costs compared to actively managed ones. In India, the average costs for ETFs could be in the range of 0.50-100 basis points (100 basis points = 1 percentage point) per annum. Compared to this, actively managed equity funds can charge up to 2.80% per annum. As a result, over the years, not only the savings on costs would get compounded, even the performance would get compounded and adds to your portfolio.

Supporters of the active fund management style often say that good fund managers can beat the market and give you higher returns, but the fact of the matter is at times even the best of the fund managers also underperform the market. One of the best things about ETFs is that if you are invested in an ETF, you would get a return that is on par with the market.
The chance of you being disappointed with your re turns in comparison with the market returns is very low according to an official at a domestic fund house.

Gold ETFs outshine others

Some of the basic attributes to look for while selecting an ETF are liquidity (how quickly you can sell your ETF without adversely affecting its market price), expense ratio (lower the expense ratio, better managed it is) and tracking error (the variance of its NAV from its underlying benchmark).

In India, of about Rs 13,000 crore worth of investors' money that is invested in ETFs of various types, about Rs 11,000 crore is invested in gold ETFs. The balance is in various other types of ETFs, like the ones which have an underlying market index, some sectoral indices, or some foreign indices.

Of the total 20-25 ETFs available in India, a majority are gold ETFs, catering to the huge popularity of gold as an investment for a large number of Indians. Globally, however, the scenario is quite different. In the US for example, the inflows into ETFs of all types together, of late, are surpassing the inflows into mutual funds. The main reason for the muted response to ETFs in India is that distributors get no commission for selling these products. In comparison, these distributors earn about 70-80 basis points per annum as trail commission for selling equity and hybrid mutual funds.

In the case of ETFs, brokers can get brokerage co mission when they are bought or sold on the exchanges. But in India, brokers mainly thrive on frequent buying and selling by their clients while the same does not (and should not) happen in the case of ETFs, veterans of the ETF space say. Since they (distributors) don't get commission, they don't sell passive funds.

So, a new model is being tried in the market. Under this, you as an investor would be required to pay the seller/distributor of the ETF while the seller/distributor will not take anything from the fund house whose scheme is being sold. In this way, the seller/distributor will be answerable and responsible to the investor fully rather than running after higher commission from the fund house and often trying to sell mutual fund schemes to an investor which may not be the best fit for his/her financial needs and risk profile.

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