He talks to BT Money Today about the risks to individual investors and more
The popularity of ETFs is on the rise, evidenced by total assets in India reaching around Rs. 6.5 lakh crores. However, investors need to be aware of the impact cost associated with ETFs, especially considering that lower liquidity in a particular ETF can result in higher costs.
For instance, within the same ETF category, like Nifty, impact costs can fluctuate considerably, ranging from as low as 0.02% to as high as 2%. It's essential for investors to evaluate the liquidity and impact costs of ETFs before making investment decisions to ensure optimal returns and minimize expenses.
In an interview with Navneet Dubey of BT Money Today, Arun Sundaresan, Head ETF at Nippon Life India Asset Management Ltd. (NAM India), sheds light on the potential risks for individual ETF investors and the considerations surrounding ETFs in the current market environment. Here are edited excerpts from the conversation:
BT: Could you explain what ETFs are and how they differ from mutual funds? Also, how should investors incorporate ETFs into their portfolios given the current market conditions?
AS: Exchange Traded Funds, or ETFs, are essentially mutual funds that trade on stock exchanges, similar to stocks or debt securities. The distinguishing feature of ETFs lies in their listing on exchanges, which allows investors to buy and sell them throughout the trading day. ETFs typically replicate specific indices, such as the Nifty 50 index, holding the same stocks in the same proportions.
Investors can leverage ETFs to gain exposure to targeted segments of the market according to their preferences and investment objectives. It's crucial for investors to assess volume and impact cost data before making investment decisions, as these factors can influence ETF performance and overall portfolio outcomes.
ETFs offer potential benefits in terms of liquidity and diversification, but investors must also be mindful of the risks associated with market volatility and fluctuating asset prices. Proper due diligence and a clear understanding of ETF mechanics can help investors effectively integrate ETFs into their investment portfolios while managing associated risks.
In the realm of ETFs, investors have a diverse array of options spanning equities, fixed income, and commodities markets. Within each asset class, investors can select from various funds tailored to their preferences and investment strategies. They can opt for market cap-based funds, such as large cap, mid cap, or small cap, or explore sectors and themes like Banking, IT, Consumption, among others, through ETFs. Additionally, there are numerous fixed-income strategies and gold and silver ETFs that offer investors the flexibility to customize their asset allocations and investment approaches. Thus, regardless of prevailing market conditions, investors can select from a wide range of ETFs aligned with their individual investment preferences.
BT: Could you elaborate on liquidity within the context of ETFs, and why is it of paramount importance for investors?
AS: Liquidity is vital to ETFs, akin to water for fish. It ensures that when investors seek to buy or sell an ETF on the exchange, there are willing counterparties available. Ample trading volume in the ETF is crucial to facilitate transactions at prices close to those displayed on the exchanges. For instance, consider a scenario where a stock or ETF is trading at Rs. 100, and an investor wishes to sell. Ideally, the sale order should execute at a price close to Rs. 100, reflecting the liquidity of the asset. However, if liquidity is lacking, the transaction may occur at a lower price, say Rs. 97 or Rs. 98, resulting in a 2-3% loss in returns due to high Impact Cost (IC). Therefore, liquidity, defined by robust trading volume, significantly impacts ETF returns.
BT: Could you elaborate on the distinction between primary and secondary market liquidity for ETFs and their respective roles?