Globally, exchange traded financess ( ETF ) have late gained huge popularity as new plus category for investing since last decennary. ETFs provide exposure for investing in plus categories such as equity, fixed income, trade goods and currencies ( Beginning: hypertext transfer protocol: //www.business-standard.com/india/news/-riseetfs/383315/ ) . Several states have reported a rise in the trading volumes of ETFs. The national stock exchange has quoted, about 60 per centum of trading volumes on the American Stock Exchange are from ETFs. The most popular ETFs are, QQQs ( Cubes ) is based on the Nasdaq-100 Index and SPDRs ( Spiders ) is based on the S & A ; P 500 Index ( Source: hypertext transfer protocol: //www.nseindia.com/content/products/prod_etfs.htm )
Rise of ETF in India
With a GDP of $ 3,526 billion in buying power para and averaging growing about 8.5 per centum for the last five old ages, India is the universe ‘s 4th largest economic system and the second-fastest growth among major economic systems ( newspaper, Times of India, August, 2010 ) . A presentation by Benchmark plus direction company indicated, the value of assets for ETFs in India, as on May 2007, had grown to Rupees 6000 crores with merely eight ETFs ( figure-1 ) as compared to a value of less than Sri lanka rupees 1000 crores in December 2002 ( Beginning: hypertext transfer protocol: //www.benchmarkfunds.com ) .
Figure-1: Growth of ETFs in India
Beginning: Benchmark AMC, 2009
“ Exchange traded funds have now started going really popular in India every bit good, with over 25 per cent of all secondary market FII flows into India coming through this path in 2009 ( about 15-20 per cent of entire FII flows including primary market issue, Credit Suisse estimation ) . Despite this accelerated flow through ETFs into India, single-country India ETFs are still highly little compared to China or Brazil. The difference in size is truly because of the much later launch of these merchandises for India due to historic regulative issues ” ( Beginning: hypertext transfer protocol: //www.business-standard.com/india/news/-riseetfs/383315/ ) .
NSE cited, the first ETF, Standard and Poor Depositary Receipts ( SPDR ) which tracked S & A ; P 500 stock index, was marketed in January 1993. Though it took several old ages for ETF to pull public involvement in India, but one time they did, the volumes took off with a retribution ( hypertext transfer protocol: //www.nseindia.com/content/products/prod_etfs.htm ) . Over past few old ages, plus direction companies have launched several ETF merchandises in India.
Sharpe ( 2000 ) quoted, “ One attack is to compare a portfolio with a market index that is constructed from the same set of securities that the portfolio director evaluates in doing investings ” . For the Indian markets the most appropriate benchmarks chosen are SENSEX and the NIFTY.
Figure-2 shows tendency of Indian Stock Market for the period 2006 to July 2010 with three distinguishable stages during the past five old ages ( Beginning: hypertext transfer protocol: //www.moneycontrol.com ) :
Growth stage from January 2006 to October 2007, a bull tally
Decline stage from October 2007 to January 2009, a bear tally and
Growth stage from February 2009 boulder clay June 2010, a recovery from recession
Figure-2: NIFTY and SENSEX tendency from January 2006 to July 2010
Beginning: hypertext transfer protocol: //www.moneycontrol.com
The above chart indicates, both SENSEX and NIFTY are sensitive to market sentiments and market worlds, capturing the roars and flops of the Indian equity market.
Bombay Stock Exchange ( BSE ) index, SENSEX, consists of 30 stocks, stand foring 12 major sectors and is tracked worldwide. With SENSEX constructed on a ‘free-float ‘ methodological analysis, BSE provides an efficient and crystalline market for trading in equity, debt instruments and derived functions ( hypertext transfer protocol: //www.bseindia.com ) .
The other index from National stock exchange ( NSE ) of India, S & A ; P CNX NIFTY consists of good diversified 50 stocks, accounting for 22 sectors. It is used for a assortment of intents such as benchmarking fund portfolios, index based derived functions and index financess ( hypertext transfer protocol: //www.nseindia.com ) .
What is Exchange-traded fund ( ETF )
Exchange-traded fund is a basket of securities, traded on an exchange, like single stocks, which are bought and sold through a broker-dealer. However it is non a stock, as it does non stand for ownership in any company. ETFs seek returns of an index by either purchasing all of the securities in proportion to their weights in the index or by purchasing a representative sample. ETFs are inactive in nature, trusting on an arbitrage mechanism to maintain the monetary values at which they trade approximately in line with net plus values ( NAV ) of their undelying portfolios. Until the development of ETFs, it was non possible to recognize the same returns of an index without the extremely expensive, active fund direction ( www.nseindia.com ) .
So an Exchange traded fund in India basically tracks a peculiar benchmark like NIFTY or SENSEX, reflecting the composing of that index.
How ETF works
The NSE explains, an plus direction company ( AMC ) which patrons ETF ( Figure-3 ) , takes the portions of companies consisting the index from assorted classs of investors like authorised participants, big investors and establishments. In bend, it issues them a big block of ETF units called a “ Creation Unit ” which is exchanged for a “ Portfolio Deposit ” of stocks and “ Cash Component ” ( hypertext transfer protocol: //www.nseindia.com/content/products/prod_etfs1.htm ) .
Trading value of an ETF is based on the net plus value ( NAV ) of the underlying stocks that it represents, given by the entire market value of the ETF ‘s securities, plus any other assets, such as hard currency, minus its liabilities, so spliting the consequence by the entire figure of outstanding ETF portions. NAV of ETF = ( Value of ETF ) / ( Number of ETF portions ) . ETF units are continuously created and redeemed based on investor demand. There is a possibility of arbitrage due to the fact there will be some difference between the NAV of an ETF and its portion monetary value, as market demand will differ by at least a little sum at any clip ( http: //thismatter.com/money/mutual-funds/etf.htm )
Figure-3: Structure of ETF
Beginning: National Stock Exchange ( NSE ) , July 2010
Investors compare the value of underlying index against the monetary value of ETF units predominating on the exchange. If the value of the implicit in index is higher than the monetary value of the ETF, the investors may deliver the units to the patron in exchange for the higher priced securities. Conversely, if the monetary value of the implicit in securities is lower than ETF, the investors may make ETF units by lodging the lower-priced securities. This arbitrage mechanism eliminates the job associated with closed-end common financess viz. the premium or price reduction to the NAV ( hypertext transfer protocol: //www.nseindia.com/content/products/prod_etfs1.htm ) .
Types of ETF in India
Though many types of ETFs with different investing aims exist globally, ETFs in India are categorized as: equity, sector specific, liquid and gold, which are listed in BSE and NSE.
In the equity ETF infinite, Nifty BeES by Benchmark AMC is the most popular ETF which aims to retroflex the returns of NIFTY index. Nifty BeES holds the stocks in the same proportion as they are present in the NIFTY index ( hypertext transfer protocol: //www.moneycontrol.com ) . Table-1 nowadayss four equity ETFs tracking NIFTY index, whereas two ETFs replicates each of SENSEX, PSU BANK and BANK indices. Additionally there is one ETF each for NIFTY JUNIOR and NIFTY SHARIAH index. The expense ratios and origin day of the month for the equity ETFs are besides presented in the last two columns of the table-1.
Table-1: Equity ETFs in India
Beginning: hypertext transfer protocol: //www.moneycontrol.com, June 2010
Liquid BeES is the lone liquid ETF in India which tracks Crisil liquid fund index ( table-2 ) . This ETF invests in a basket of call money, short-run authorities securities and money market instruments of short adulthoods while keeping safety and liquidness ( www.benchmarkfunds.com/Products/LiquidBeES/Overview.aspx ) .
Table-2: Liquid ETF in India
Beginning: hypertext transfer protocol: //www.moneycontrol.com, June 2010
Six gold ETFs are available to Indian investors ( table-3 ) . While comparing the expense ratios of all gold ETFs, Gold BeES from Benchmark AMC has the lowest disbursal ratio of 1 per centum followed by Quantum fund ( 1.25 ) . The staying gold ETFs have higher disbursal ratio of 2.5 per centum.
Table-3: Gold ETFs in India
Beginning: hypertext transfer protocol: //www.moneycontrol.com, June 2010
Figure-4 below nowadayss the volumes for these gold ETF, which indicates the liquidness of investing. Gold BeES has the highest volume among all gold ETFs in India ( hypertext transfer protocol: //www.onemint.com/2010/04/19/which-is-the-best-gold-etf-in-india/ ) .
Figure-4: Comparison of Gold ETF volumes in India
Beginning: hypertext transfer protocol: //www.onemint.com/2010/04/19/which-is-the-best-gold-etf-in-india/
Among the available types of ETFs in India, it is apparent that the largest class of ETFs are those tracking NIFTY index and Benchmark AMC being the innovator, have the most figure of ETF merchandises covering all the types.
Comparison of ETF with MF
Common financess ( MFs ) is one of the most popular option in India, with a figure of fund houses and strategies, for investors looking to an exposure in equities. Figure-5 below shows major functional differences between ETFs, stocks and MFs. Clearly, ETFs have all the advantages of both stocks and MFs, giving more power to investors. In kernel, ETFs trade like stocks and hence offer a grade of flexibleness unavailable with traditional common financess. ETFs are different from Common financess in the sense that ETF units are non sold to the populace for hard currency. Another chief merchandising point is, ETFs are cheaper than traditional common financess in footings of fees ( hypertext transfer protocol: //www.nseindia.com ) .
Figure-5: Comparison of ETF versus Stocks and Mutual Fund
Beginning: Hand book on Exchange Traded financess, NSE
Statement of job
Exchange traded financess ( ETF ) have emerged as an alternate investing vehicle to traditional stocks and common financess ( MFs ) in India, which has opened up doors to great involvements for both investors and research workers. Several surveies on ETFs have analysed for the American and European markets, but non for Indian ETF market. Since India has a figure of MFs and emerging ETFs with assorted investing aims, for a retail investor, taking to put in ETF is a complex determination. Furthermore placing a successful ETF for an investor is genuinely apprehensible. Hence this survey intends to measure the public presentation of ETFs in India in footings of returns for the given hazard degrees at which they are delivered in comparing with the market and the hazard free rates. Besides there are barely few surveies that evaluates public presentation of ETFs over the actively managed MF opposite numbers in India. The purpose of this survey, is to place the outperforming ETFs which in bend helps investors to pick the right investing vehicle. In this context, the writer finds it indispensable to analyze the public presentation of the Indian ETF industry.
Aims of this survey
The present survey has the aims of happening out the necessary facts sing public presentation of selected ETFs. The specific aims of the survey are:
First, to compare average return and hazard of ETFs retroflexing their trailing indices.
Second, to compare average return and hazard of ETFs with MFs.
Third, to compare and rank the risk-adjusted public presentation of ETFs along with MFs.
Finally, we focus on the factors that cause any differences in public presentation
Chapter 5: Performance analysis on ETF
Superior public presentation of Gold ETF
GoldBeES ETF has performed exceptionally good during the period of survey, including the recent recession driven by uncertainness and rising prices. Even when comparing the passively managed GoldBeES ETF with other ETFs and MFs, it has earned a 2nd rank ( table-18 ) in footings of Sharpe and Jensen steps. The one-year mean correlativity between GoldBeES and NIFTY index from mid 2007 to mid 2010 was comparatively stable around zero but varied somewhat in the short tally, fluctuating between -0.064 and 0.425.
The ground for superior public presentation of Gold ETFs could be due to the fact reported by the Economic times ( May 2010 ) that, India is the universe ‘s largest consumer of gold, about 20 % to 25 % ( over 800 metric tons ) of universe production.
Figure-17: Wordlwide demand for gilded ETF
Beginning: Religare Gold Exchange Traded Fund, 2010
Moreoever, when markets were seized by terror during twelvemonth 2008, investors flocked to gold investings as the ultimate safe-haven plus because it carried lowest hazard than equity markets. Globally the influxs into ETFs have therefore far continued unabated, buoyed by mass meeting in gold monetary values and as an effectual hedge against rising prices. Harmonizing to a study from Religare gold ETF ( 2010 ) , a combination of higher gold monetary values coupled with comparatively low volatility of gold, have pushed demand for the Gold ETFs worldwide to enter highs in twelvemonth 2009 ( figure-17 ) .
This logical thinking is supported with the fact that gold ETFs retention is globally ranked 6th ( figure-18 ) vis-a-vis other cardinal Bankss and IMF gold militias. Retentions of the universe ‘s largest gold Exchange traded fund, the New York listed SPDR Gold Trust, touched a record high of over 1192 metric tons on May 2010. The Reserve Bank of India bought 200 metric ton in November 2009, forcing up the demand for gilded ETFs ( Source: Religare Gold ETF, 2010 ) .
Figure 18: Gold ETF ranks 6th globally
Beginning: Religare Gold Exchange Traded Fund, 2010
The economic times ( May 2010 ) of India quoted, if the current demand-supply kineticss continue, gold monetary values will travel inexorably higher. Gold ETF are a large success universe over and India has merely entered this plus category. This means the public presentation of GoldBeES may besides surge to new highs in the coming old ages. However analysts keep claiming that gold monetary values have gone up due to quantitative moderation and the twenty-four hours the quantitative moderation is withdrawn, evidently gilded monetary values are traveling to see some sum of following back, but it remains to be seen if GoldBeES can crush index in general market conditions.
Performance comparing of ETF and MF
There is a enormous growing in common financess ( MFs ) sector from past few decennaries as it has a assortment of strategies. Common financess in India are suited for secured and bad investor, irrespective of age, category and type of investors. Though the volatility and beta of MFs remained in the same scope of ETF during the survey period, Reliance growing and HDFC balanced MFs produced significantly higher risk-adjusted returns than equity ETFs, corroborating the observations of several surveies over decennaries, like Pennathur et Al. ( 2002 ) , Gastineau ( 2004 ) , Neal et Al. ( 1998 ) and Richards et Al. ( 1980 ) in the literature. The three risk-adjusted public presentation steps clearly indicates significantly higher public presentation of MFs over ETFs by approximately 15 to 22 points in Treynor ratio and 3 points in Sharpe ratio.
Harmonizing to concern criterion ( February, 2010 ) , the driver of the ETFs ‘ in India has been their low disbursal ratio compared to actively pull off financess. Domestically listed ETFs in India have typical disbursal ratio around 1 % vs 2.5 % for domestically listed common financess. Though ETFs are cheaper for investors in India, the sad truth is that over the last four old ages, really few Exchange traded funds have been able to outpace the benchmarks by adequate border to warrant their fees. Most of equity ETFs other than GoldBeES ETF, failed to crush market returns as seen from the earlier analysis. The public presentation delivered by sample active financess chosen in this survey is clearly higher than market. In general market conditions, the taking fund direction houses may go on to bring forth outperformance relation to index anyplace between 5-20 % points on an one-year footing.
Equity ETF fail to track Indexs
It can be inferred both NIFTY and SENSEX retroflexing equity ETFs have failed to track benchmark as depicted by ranking of financess in table-18. Analysts say this may be due to miss of liquidness but can non explicate the volatility. Ideally in an index based ETF, the NAV should be near to the last traded monetary value. However these ETFs showed a immense difference between their last traded monetary value and their NAV, get the better ofing the intent of these instruments. For illustration, ICICI Prudential ‘s Spice ETF, which tracks 30 SENSEX stocks, showed a difference of over 11 points between its last traded monetary value and the NAV. Its last traded monetary value on the exchange was Rs 189, but the NAV is Rs 167.87. Similarly, in instance of UTI Sunder, which tracks the NIFTY, the difference was 28.2 and in instance of Quantum ETF, the spread was 17 points ( Business criterion, February 2010 ) .
No liquidness in ETF
Analysts quoted that deficiency of liquidness were the chief ground for unnatural monetary value motions in these ETFs. Since these are illiquid instruments, there are cases when there were lone purchasers. In such a scenario, the monetary value kept traveling up. It clearly showed carelessness on the portion of plus direction companies ( AMC ) towards guaranting liquidness of their ETF. The fund houses did non trouble oneself about ETF after they were launched. Since the investor base was little, it resulted in the market monetary value being different from the NAV. Some analysts said in malice of holding a lower investor base, the wild monetary value motions in these ETFs were rather unusual ( Business criterion, February 2010 ) .
Low trading volumes of ETF
As per the empirical findings, many ETFs have underperformed the underlying index by a important border of 2 % and above in footings of one-year returns which is considered to be important for an investor. Harmonizing to table-1 to table-3 ( in chapter-1 ) , origin of bulk of ETFs was from twelvemonth 2007 onwards and therefore the construct of ETFs is still new among retail investors in India. Additionally, purchasing a common fund is more convenient than purchasing an Exchange traded fund at the minute which leads to take down retail incursion and hence lower trading volumes of ETF. The ETF investors could be confronting the dilema argued by Bernstein ( 2004 ) that the revenue enhancement and cost advantage of ETFs is modified or eliminated by the enticement of investors to neutralize their portions often. It is plausibile, lower institutional purchasing of ETFs is besides lending to take down trading volume. Harmonizing to an article in website “ navindia.com ” , as on May 2010, the assets under direction ( AUM ) of equity ETFs stood at merely Rupees 1,431 crore, whereas the AUM of equity MF was Rupees 171,681 crore. The net influxs in May 2010 were merely Rupees 185 crore for equity ETF as compared to Rupees 1256 crore for equity MF. Trading volume is positively influenced by the size of ETFs bought and sold connoting that higher investing involvement from institutional investors can ensue in greater trading volumes in ETFs than retail investors. Finally, tracking mistake may coerce investors to sell the ETF portions they hold, connoting a positive connexion among ETFs volume and tracking mistake.
Large tracking mistake in ETFs
The following issue concerns the big tracking mistake of ETFs, which reflects the divergency among the public presentation of ETFs retroflexing their index. Assorted surveies by Frino and Gallagher ( 2001 ) , Kostovetsky ( 2003 ) , and Blume & A ; Edelen ( 2004 ) points to multiple major factors that cause big tracking mistake in these ETFs. They are, assorted disbursals and dealing costs originating from index alterations, dividend payments originating from the stocks of an index every bit good as the size and the timing of index ‘s rebalancing, the market clashs that hurt the ability of index trackers to retroflex precisely the public presentation of the underlying indexes, the bid-ask spreads, hard currency required to run into salvations of investors, and seasonal effects in tracking mistake magnitude.
The high overall tracking mistake ( table-19 ) depicts, many of the equity ETFs did non populate up to their promise of closely tracking their benchmark. As observed by Sharpe ( 2000 ) , positive tracking mistake can be observed in GoldBeES ( 5.20 ) , UTI Sunder ( 1.40 ) and Quantum ETF ( 1.37 ) which consequently indicates outperformance with regard to their index. However, big negative trailing mistake is observed in Kotak PSU ( -2.22 ) , Nifty BeES ( -3.62 ) and Kotak Sensex ( -3.04 ) ETFs as confirmed by their underperformance. Harmonizing to research informations reported in concern criterion ( February 2010 ) , the tracking mistake in instance of an ETF should non be more than 0.5 per centum.
Table-19: Tracking mistake of ETF
The intuition here is that, the higher the volatility of the components in ETF, the more hard it is to track them. Consequently, the standard divergence was observed to be high ( table-6 to table-16 ) in the scope of over 5 to 6 points for old ages 2008 and 2009 as compared to standard divergence of 2 or 3 during twelvemonth 2007 and 2010. Majority of big tracking mistakes must hold occurred when the pandemonium of 2008 started to impact returns and extended into twelvemonth 2009.
Another idea from writer is, although fees and costs necessarily affect the public presentation of an ETF, the underperformance was well larger than the mean entire disbursals ratio, proposing costs could non be the lone account. As the market has shown utmost fluctuations during the recession period, the reaction clip taken by fund directors to set the portfolio and holding hard currency in a portfolio in the upward trending market, could be one cardinal ground for higher tracking mistake in these ETFs. Furthermore, ETF directors who wish to rectify their portfolios to hold low degrees of tracking mistake are likely to keep more securities and to burden the portfolio similar to the benchmark index. As quoted by David Blanchett ( 2008 ) , while increasing the figure of securities lessenings tracking mistake, it increases monitoring costs and reduces the ability of the portfolio director to work the “ best thoughts ” .
Inadequate variegation of equity ETFs
One of the chief grounds for some equity ETFs neglecting to fit the market returns in India, can besides be attributed to inadequate variegation. This can be confirmed by sing the scope of beta ( 0.809 to 1.026 ) and that most equity ETFs have beta statistically different than integrity. Though increasing the figure of securities in ETF may cut down the hazard further and accomplish returns similar to its tracking index, the diversified portfolio may go from the subject of indexation. Since the two MFs have significantly outperformed the market index, farther strengthens the fact that they are good diversified than ETFs. However the job is, the figure of securities necessary to accomplish variegation varies from clip to clip. The Exchange traded fund directors can implement the recommendation of Goetzmann and Kumar ( 2005 ) to divesify the portfolio while sing the fact that correlativity among stocks within the portfolio must non be high. This fact has been proved with the superior returns of GoldBeES ETF which has near zero but marginally negative correlativity to NIFTY index.
Superior public presentation of Gold ETF
The risk-adjusted returns confirmed that GoldBeES ETF has performed the best among all ETFs by bring forthing higher returns with lower hazard during the period of survey, which includes the recent recession. However it can non be concluded if this GoldBeES ETF has outperformed the market because of including the recent recession period, chiefly during twelvemonth 2008. Probe on the public presentation of gold ETF outside the recession to find if the GoldBeES would execute good even in general market conditions is beyond the range of this survey.
Assorted public presentation of equity ETF
The analysis in predating subdivisions, confirm assorted consequences on public presentation of equity ETFs. About three equity ETFs have matched or marginally overperformed their benchmark and three ETFs have underperformed their benchmark during the survey period. The underperforming ETFs have burdened their investors with lower risk-adjusted returns. The grounds for under-performance of the three equity ETFs are analyzed to be: lower liquidness, lower trading volumes and higher tracking mistake with regard to index. Since the ETFs have varied ranking among the three steps, the consequence agrees with Levy ( 2002 ) that ETFs have some unsystematic hazard constituent in them and therefore may non be to the full diversified as compared to benchmark.
MFs outperformed ETFs
The superior public presentation of active MF directors over ETFs demonstrates the ability of active fund directors in India to foretell security monetary values and in bend picked stocks that provided higher risk-adjusted returns, crushing the market by a immense border. This survey concludes, in the Indian market, the empirical findings strongly back up the theory that there is a possibility to bring forth unnatural returns by MFs over ETFs utilizing active direction schemes. Hence harmonizing to Famas ‘ ( 1970 ) EMH theoretical account, the Indian capital market is semi-strong signifier efficient. However it remains to be seen if MFs in India can prolong higher public presentation over market in the long tally. Though equity ETFs are emerging in India, there is a demand to concentrate aggressively on two foreparts – public presentation and merchandises, to vie against the well established common financess and court more retail investors. Clearly ETFs in India has yet to present.
Chapter 6: Discussion
Writers ‘ contemplation
The aim of this survey is to compare the hazard and return public presentation of exchange-traded financess ( ETFs ) with benchmark and common financess ( MFs ) in India. Seven ETFs and two MFs are included in the sample for clip period from April 2007 to July 2010. The placeholders for public presentation used are average returns and risk-adjusted returns over the sample period.
First, the consequences show that GoldBeES and equity ETFs – UTI Sunder and Quantum have earned higher returns than Index, but have clearly lower returns than MF sample. The staying three equity ETFs exhibit lower mean returns than index, which is due to higher tracking mistake. Second, the consequences indicate that ETFs have lower steps of Sharpe, Treynor and Jensen, than the MFs. This indicates that a inactive investing scheme using ETFs did non give superior risk-adjusted returns as compared to an active investing scheme of MFs. This consequence is further supported by the determination that a bulk of the MFs evaluated here exhibit important positive alphas over the sample period.
Deductions for efficient market hypothesis ( EMH )
Empirical analysis revealed, common financess ( MFs ) in India, during the period of survey, produced unnatural returns much higher than benchmark, which indicates market is non genuinely efficient, as it is possible to do net income significantly higher than the chosen benchmark. However making sustained unnatural returns is inconsistent with the well known EMH. It is possible that MF directors may hold entree to some cardinal information which allows them to do unnatural returns. Harmonizing to Sharpe et Al ( 1999 ) , it should be impossible for common fund directors to happen undervalued companies unless the market is inefficient.
Raja, Sudhakar and Selvam ( 2009 ) , conducted trials to find the market efficiency with regard to information which resulted in Indian stock market falling under semi-strong signifier of efficiency. Some surveies by “ The Reserve Bank of India ” have done trials on authorities securities markets in India and have confirmed the Indian stock market is semi-strong signifier efficient. This survey has non provided any grounds to reject that statement.
Lower incursion of ETF in India
The grounds why an investor underestimates ETFs ‘ possible and overestimates common fund would necessitate a thesis on its ain to explicate. The consequences of this survey coincides with the observations of Gastineau ( 2004 ) on the underperformance of ETFs with regard to MFs. The writer explores few grounds that could hold contributed to lower incursion of ETF and therefore indirectly impact its public presentation.
First, investors overrated common financess as a consequence of being able to do higher returns than index in short term. Therefore investors flocked to common financess even if they had to pay higher fees to fund directors. On the other manus the returns of ETF, which is about the same or lower than index, might be viewed as “ drilling ” , particularly in bull market and hence investors may hold opted out of ETF.
Second ground is, common fund strategies are extremely matured in India and have demonstrated their returns on NAV addition higher than index, in the yesteryear. So investors extrapolate this historical success into future. The opposite might keep for new ETF instruments except GoldBeES, that does non hold any success to show. Hence investor incursion for ETF remains weak and therefore perceived to execute worse than common financess until proved successful.
Third ground is, the statement of Lakonishok, Shleifer and Vishny ( 1992 ) can be applied to the unpopular ETF. If there is less public information and greater information dissymmetry on ETF, so investors may fear success of ETF and demo herd like behavior by accepting determinations of other investors who invest in common financess.
Deductions for investors
A survey conducted by Anand and Murugaiah ( 2008 ) in India have demonstrated that absolute accomplishments of fund directors remain the same but their accomplishments relative to market maintain diminishing. The ground being the direct effect of a market be givening towards higher efficiency in which monetary value finds are quicker. So the deductions for investors is that past public presentation of common financess is no warrant for future public presentation. An investor seeking long term exposure in equity is likely to acquire disaapointed by semblance that all common fund directors will present alpha systematically. Of class at any given point, some fund directors out of the many will be able to surpass but this is random. Another of import deduction for market participants is that ETFs offer lower information dissymmetry and hence lower losingss than MFs. So we can safely reason that outperformance of MF could be mostly due to luck instead than selectivity accomplishments of fund directors.
Sharpe ( 2000 ) explained, investors need to be cognizant that market outperformance is a “ nothing amount ” game. This means for some investors to surpass the norm, others by default has to underachieve. In other words, all investors as a group earn merely stock market ‘s mean return including the active fund directors. The deduction to investors is, for each excess return that an active fund director earns, another fund director suffers a loss in returns precisely by the same proportion.
For an investor the inquiry is, what type of investing should they travel for: passively managed ETF or an actively managed common fund? In many authoritative active versus inactive arguments in Indian media, advocates of active fund direction have ever claimed the Indian fund directors will be able to surpass the benchmark and generate alpha. The most common one is, Indian markets are inefficient and fund directors are secluded to information or their degree of mind is much higher than the market of which they themselves are portion.
This statement is in direct contrast with the world of developed markets in which research has proved that there is no fund director in the universe who has managed to crush the index systematically over clip. Financial research by Sharpe ( 1966 ) , Jensen ( 1968 ) , Henriksson ( 1984 ) and Malkiel ( 1995, 2003a, 2003b ) point out that common financess on norm under perform the market index by the sum of disbursals incurred by them. Furthermore, they mention that the superior public presentation of actively managed financess is rare over long clip and normally undistinguished. Sharpe ( 2000 ) has affirmatively stated “ Properly measured, the mean actively managed dollar must under execute the norm passively managed dollar, cyberspace of costs. Empirical analyses that appear to rebut this rule are guilty of improper measuring ” . Indexing is a nucleus investing passive scheme for both institutional and retail investors. An indexed scheme is expected to surpass a bulk of likewise positioned active directors over the long term. A rational investor should travel for the winning scheme depending upon short term or long term end to increase the value of their investings.
Theoritical Progresss in ETF
The comparing of ETFs and common financess offers some penetration on the comparative advantages of each type of investing. Given the consequences found here, there may be some possible for extra types of ETFs that are less open to put on the line or mid-cap stocks that have record of higher public presentation than large-cap stocks. Since actively managed financess are more sought by investors, it would be interesting to cognize about actively managed ETF.
Rob Arnott, the guru of cardinal indexation, launched his first actively managed ETF in USA in twelvemonth 2005. Since so Mr. Arnott has generated a big fan following as other investors have sought to mime the “ best of both universes ” merchandise that basically indexed ETFs seek to offer, the returns of actively managed financess with the costs akin to that of a tracker fund. If Mr.Arnott ‘s techniques can be used successfully in India, it will hold of import branchings for the fiscal services industry. Motilal Oswal plus direction in India has attempted a basically indexed version of NIFTY. This is the first launch of an actively managed ETF merchandise in India and if it succeeds, it will non merely bring forth a host of imitators but could besides assist hike the wafer thin net income borders of the Indian plus direction industry. ( Saurabh Mukherjee, May 2010 )
Criticism on rating theoretical accounts
The writer would wish to indicate out that the theoretical accounts used in order to carry on this survey have been chosen with great attention in order to acquire the consequence as indifferent and unskewed as possible. In malice of this careful choice, there could be many defects in the three rating theoretical accounts of which few major points are discussed below:
The writer agree with Levy ( 2002 ) that the three steps, Sharpe ratio, Treynor ratio and Jensen alpha used in mensurating public presentation of ETFs and MFs, varied in ranking ( table-18 ) . Inspite of the difference in consequences, these popular theoretical accounts are extensively used for measuring portfolios to derive a position on investing.
Note that if the market index used is inefficient, securities and portfolios secret plan above and below the Security Market Line for Treynor and Jensen steps. Therefore, we can non state if a portfolio ‘s place relation to the SML is due to public presentation, or merely due to the inefficiency of the market index. In other words, a portfolio ‘s place relation to the SML is sensitive to the inefficient placeholder chosen to stand for the true market portfolio ( Bodie et al, 2009 ) .
Some research workers have explained that Jensen index is sensitive merely to depth which is the magnitude of extra returns and non the comprehensiveness which is magnitude of residuary discrepancy – is the portfolio good diversified. Since beta is used as a hazard step, merely systematic hazard is relevant here and non residuary discrepancy. Hence Jensen ‘s step is non suited for ranking portfolio public presentation, although it can be modified to make so. The CAPM used by Jensen step, does non uncover whether portfolio public presentation is due to direction accomplishment or merely due to an inaccurate index of the true market portfolio ( Levy, 2009 ) .
The Sharpe ratio is upward biased to low hazard portfolios and downward biased to high hazard portfolios. There is no easy manner to rectify the Sharpe ratio for this job. Since the standard divergence of returns is the hazard step in Sharpe ratio, it is merely appropriate for portfolios and non for single securities ( Bodie et al, 2009 ) . As we are non utilizing Sharpe ratio to mensurate the public presentation of any individual security, this restriction can be ignored for this survey.