The investment scenario in India is constantly evolving. Contrary to traditional investment approaches such as stocks, real estate, fixed deposits (FDs), etc., investors are exploring new-age investment channels that present a range of opportunities.
The Indian mutual fund industry AUM has reached Rs 39.46 lakh crore as on February 28, 2023, from Rs 8.14 lakh crore as on Feb 28, 2013, a massive five-fold rise in the decade. Additionally, the AUM of passive funds grew at a rate of 57 per cent between 2017 and 2022, wherein the number of passive funds in India grew from 84 to 228.
Also, the asset under management (AUM) of Nifty 50 ETF touched Rs 5 lakh crore in 2022. The multi-fold increase in the ETF and Indian MF industry highlights the increasing paradigm shift of Indian investors from traditional to more developed investment channels. ETFs and mutual funds help investors diversify portfolios, mitigate risks, and earn increased return on investment (ROI).
ETFs vs Mutual Fund
ETFs and mutual funds are investment vehicles that allow potential investors to pool their funds together for investments in different industries. Both these instruments have their own resemblances and differences.
Diversification Across Sectors and Industries
The ultimate goal of MFs and ETFs is to allow investors to diversify their portfolios by investing in a range of assets across different industries and sectors. Rather than investing in one particular sector, these investment vehicles enable investors to mitigate risk by investing across different industries.
Cost-Efficiency
Secondly, both mutual funds and ETFs typically offer cost-efficient ways for investors to access portfolios with optimal transaction costs and fees compared to buying individual stocks and bonds.
Expense Ratios
ETFs have lower expense ratios than mutual funds as ETFs generally have fewer operational charges associated with them. And ETFs can be purchased in single units, while mutual funds often have minimum investment requirements.
The expense ratio, i.e., operating expenses divided by the average assets of the funds, is much lower for ETFs. It ranges between 2-5 basis points (0.02-0.05 per cent). In contrast, the total expense ratio of mutual funds in India ranges between 0.80 per cent and 2 per cent due to higher management fees and transaction costs.
Transparency
ETFs and MFs also provide investors with information about their holdings on a regular basis. This level of transparency allows investors to see exactly what assets are held in the fund and the weightings of each holding.
Balancing ETFs with Mutual Funds in your Investment Portfolio
ETFs are structured as a basket of securities that trade like stocks on stock exchanges, and their prices fluctuate throughout the trading day, whereas mutual fund prices are calculated at the end of the trading day based on the underlying assets’ net asset value (NAV).
Tax Efficiency
ETFs are generally more tax-efficient, as they tend to have much lower turnover, which can result in lower taxes for investors. Thus, ETFs can avoid taxes generated from turnover. On the hind side, due to the purchase and redemption activities of most mutual funds due to active investment style, the capital gain distribution is higher. Resultantly, the taxable amount of capital gains are borne by investors at an appreciated price.
Active, Passive Management of Funds
Mutual funds can provide more active management and customization, as fund managers have the ability to buy and sell securities within the fund without being restricted by the liquidity or the mechanics of the ETF structure.
ETFs replicate the performance of the benchmark index. Thus, investment in ETFs enables investors to leverage a passive investment style with an aim to match the market performance.
Depending on the goals, objectives, risk tolerance, and preferences of the investor, a balanced portfolio of ETFs and mutual funds can fetch investors lucrative returns at lower operating costs. However, it is important to consider the fees, expenses, tax implications, etc., of MFs and ETFs before investing, as there are numerous investment vehicles to choose from.
The Way Forward
Overall, ETFs and MFs can be valuable tools for Indian investors looking to diversify their portfolios, reduce costs, and achieve a more targeted asset allocation. The adoption and growing popularity of these investment instruments has been on a massive scale in developed markets like the US and have resulted in cost-effective and diversified investing by US investors. Considering their success in the US, the ground is ripe for developing economies like India.
However, robust mechanisms, proper ETF and MF infrastructure, product awareness, and technological solutions are needed for seamless access to ETFs in India. Going forward, artificial intelligence (AI) and cutting-edge technological advancements can enhance greater investing experience and can be a big part of Indian investors portfolios when it comes to ETF investments.
(The author is co-founder of financial technology platform ETF Junction)
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