Exchange traded funds (ETFs) are index based investment products that allow investors to buy or sell exposure in an index through a single financial instrument .ETFs are funds that trade on a stock market like shares of any individual company. They can be traded at any time during market hours and can be sold short or margined. But they are shares of a portfolio, not of an individual company. They represent shares of ownership in either open-end funds or unit investment trusts that hold portfolios of stocks or bonds in custody, which are designed to track the price and yield the performance of underlying indices.
Gold exchange-traded funds (ETFs) aim to track the price of gold i.e.; the underlying asset is gold.
In 2001, GS Nifty BeES is the first ETF (Exchange Traded Fund) in India. India's first Gold ETF is Gold BeES from Benchmark AMC which listed on the NSE in March 2007.
The AMC buys the underlying asset of an ETF and creates shares out of it. The shares are then sold in the market to investors through New Fund Offer. Shares of ETFs are bought and sold in the secondary market, such as on a stock exchange, just as shares of stock are bought and sold. Unlike most equities, however, an ETF can issue new shares and redeem existing shares on any trading day, in a process referred to as “creation” and “redemption”, which is open to qualifying entities that register as Authorized Participants with the fund. This mechanism allows an Authorized Participant to exchange a portfolio of stocks and receive ETF shares in return (i.e., a “creation”). Similarly, an Authorized Participant can “redeem” ETF shares and receive the portfolio of stocks. An Authorized Participant is usually an institutional investor or market maker who has signed a participant agreement with an ETF sponsor or distributor. Becoming an Authorized Participant allows the entity to transact directly with the fund or trust on an “in-kind” basis
· Net Asset Value per share - This is the Net Asset Value of the fund divided among all the outstanding shares.
· Dividend - Some ETF's have dividends, so you can decide to choose between two similar ETF's based on which one pays you a higher dividend.
· Individual holdings valuation - You can always evaluate each of the fund’s holdings and see if you think the market is over-valuing or undervaluing each individual stock.
· ALTAR Score Formula :
Altar Score = ROEavg=PBVFY1-fees
where ROEavg is the average Return on Equity over the course of the business cycle and P/BV is the price-to-book value multiple for the current forecast year (“FY1”). Finally, we subtract fund fees, which diminish returns realized by investors but are not typically a big driver of results.
The aim of this approach is to provide an estimate of returns from an owner’s perspective. In other
words, if an investor had enough money to buy these businesses outright and operate them for his
own benefit, what sort of rate of return could he expect? Expressed as a percentage—higher being
better—this is an internal rate of return, with no forecast of how the market may value these
securities in the future.
ETF Market in USA:
U.S.A. has a very large ETF market. As of September 2010, there were 916 ETFs in the U.S., with $882 billion in assets, an increase of $189 billion over the previous twelve months.
The following are the types of ETF present in U.S.A.
Category
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Sub Category
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Equity ETFs
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Broad market ETFs
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Major index-tracking ETFs
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Market sector ETFs
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US domestic sectors
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Global sectors
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Style ETFs
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Large-cap ETFs
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Mid-cap ETFs
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Small-cap ETFs
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International ETFs
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Country ETFs
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Regional ex-US ETFs
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Broad ex-US ETFs
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Category
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Sub Category
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Real estate ETFs
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Bond ETFs
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Fund of funds ETFs
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Commodity ETFs
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Agricultural ETFs
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Energy commodity ETFs
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Industrial commodity ETFs
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Precious metals ETFs
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Leveraged & short ETFs
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Short ETFs
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Leveraged ETFs
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Leveraged short ETFs
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The market is distributed among these types .However the recent top performing major funds are mainly international and sector specific.
Top performing major ETFs:
ETF Name
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Type
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iShares MSCI Mexico Index Fund
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International
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MidCap SPDR Trust Series I
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BroadBased
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iShares COMEX Gold Trust
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Sector
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iShares MSCI Brazil Index Fund
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International
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Select Sector SPDR Fund - Energy Select Sector
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Sector
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The above mentioned ETFs have assets in billions of dollars and the trading volumes are in millions.
ETF market in India:
The ETF market in India is of recent origin. It is more than Rs.5000 crore in size.
Major ETFs in India
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SBI Gold Exchange Traded Fund
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Reliance Gold ETF
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Quantum Gold Fund
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UTI Gold Exchange Traded Fund
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Kotak Gold ETF
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HDFC Gold Exchange Traded Fund
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Axis Gold ETF
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GS Gold BeES
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ICICI Pru Gold ETF
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GS Nifty BeES
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Kotak Nifty ETF
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GS Liquid BeES
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Issues with the Indian ETF market:
1. Small number of players
2. Low liquidity
3. High premiums
The market has currently less than 40 ETFs with the largest player having an asset base of around Rs.3000 crore. There are just around a dozen with more than Rs 100 crore in assets. This has caused problems to the investors. One case point is UTI Sunder .It gained about 150 % in around a month and was trading at 4 times its NAV at its peak. However, the trading volumes were in single digits.
So why has the Indian ETF market been facing so many problems? In order to know the reason we have to examine what it takes to create a successful ETF.
1. The index being tracked: ETFs usually track an index or a commodity like gold. The Indian market is dominated by ETFs which track Gold and S&P CNX Nifty Index.
The return of an ETF depends on the object being tracked. The better the return on the object the better the return on the ETF. Gold has been experiencing rapid growth in value. The gold ETFs have been able to attract a lot of investors. But other ETFs such as those tracking PSU banks haven’t been able to attract investors since the returns from PSU bank stocks haven’t been attractive.
There are many other indices which have been doing well in the recent past but don’t have ETFs tracking them. Following are the indices which have shown a growth of greater than 100 % over a 3-year period.
CNX IT
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BSE BANKEX
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BANK Nifty
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CNX NIFTY JUNIOR
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CNX Midcap
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BSE Auto
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BSE Metal
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BSE INFORMATION TECHNOLOGY SECTOR
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BSE HEALTHCARE SECTOR
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BSE CONSUMER DURABLES SECTOR
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In fact, there have been a few USA based ETFs which invest in the Indian market and have been experiencing significant returns and most of them are tracking indices which have been ignored by Indian ETFs.
They are:
WisdomTree India Earnings Fund
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PowerShares India Portfolio
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iShares S&P India Nifty 50 Index Fund
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India Infrastructure ETF
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India Small-Cap Index ETF
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Emerging Global Shares Indxx India Small Cap Exchange Traded Fund
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Direxion Daily India Bull 3X Shares
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EG Shares India Consumer exchange-traded fund
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Direxion Daily India Bear 3X Shares
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Hence there is a need for ETFs which track better performing indices.
2. Timing of the issue and the consequent market growth:
After the New fund Offer the ETFs growth is decided by the growth prospects of the underlying assets. The returns are usually greater during the up business cycle rather than the down business cycle and these are open-ended funds. The amount invested will depend on the returns. So the chances of an ETF succeeding are greater if it is launched during boom time.
3. The company launching the fund:
Since the ETFs tracking public indices are like commodities of the ETF market, all things being equal, the investors would more likely invest in an ETF of a well known company than otherwise.
4. The expense ratio:
The returns on the ETFs are to a certain extent decided but the expense ratio. All things being equal ETFs with lower expense ratios obviously provide better returns. Companies usually have expense ratios in the range of .4 % - 1.5 %.
5. The liquidity of the fund in the market:
For the ETFs to be priced appropriately the market needs to be liquid so that any differences are eliminated by arbitrage. Also lower or no liquidity will make it difficult for the investors to exit from the fund which will make the fund unattractive. Although there is little the companies can do to increase liquidity, one possible thing to do is to split up the ETF shares and also decrease the number of units in the block size that can be created and redeemed.
6. Market makers:
The more the market makers the better. But their number is a function of the attractiveness of the market . So the previously mentioned points need to be taken care of to attract market makers.
Looking at the above points we can say that it will be some time before the problems faced by the Indian ETF market are resolved.
Article by
Harish Dasa
Executive Member of FINATIX,
PGP 2011-2013.
For any further discussion and suggestions he can be reached at
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