ETF is one of the fastest growing mutual fund categories

Exchange-traded funds (ETFs) are passive schemes tracking market benchmark indices like Nifty, Sensex etc.

Passive mutual fund schemes as a broad category are one of the fastest-growing categories in mutual funds. In the last one-year, passive funds’ assets under management (AUM) grew by 40% (source: AMFI, as on 28th February 2023). If we compare passive funds AUM growth with that of actively managed equity funds, active equity funds AUM grew by 16% on year on year (YOY) basis source: AMFI, as of 28th February 2023); passive AUM growth rate was more than 2.5 times faster than active equity AUM growth rate.

Within the passive mutual fund, exchange traded fund (ETFs) is the largest category. ETF AUM was more than Rs 5 lakh crores on 28th February 2023 (source: AMFI). ETF, as a category, is the largest mutual fund category in India. The second largest mutual fund category, liquid funds with Rs 3.8 lakh crores of AUM is some distance behind ETFs. In the last one-year ETF AUM grew by 22% (source: AMFI, as on 28th February 2023), a huge growth rate considering that the base has itself become quite large (Rs 5 lakh crores).

What is ETF?

Exchange-traded funds (ETFs) are passive schemes tracking market benchmark indices like Nifty, Sensex etc. ETFs invest in a basket of securities that replicate a market benchmark index. The weights of securities in the fund mirror the weights of the constituents in the index. ETFs do not aim to beat the market benchmark index they are tracking; they simply aim to give market returns. ETFs are listed on stock exchanges and trade like shares of companies. You need to have Demat and trading accounts to invest in ETFs.

What are the reasons for ETFs growing in popularity?

We are seeing a trend in terms of a shift to passive mutual fund schemes in India. This trend accelerated after the onset of the COVID-19 pandemic. In the last 3 years, ETF AUM multiplied by 2.5 times (source: AMFI, as on 28th February 2023). The explosive growth of Exchange Traded Funds’ AUM in the last 3 years can also be attributed to the phenomenal growth of demat accounts over the last three years. In the past 3 years, the numbers of demat accounts have more than tripled and reached nearly 11 crores (source: Economic Times, as on 31st December 2023).

One of the reasons for ETF funds growing popularity in India is the fact that the Indian equity market is maturing. High institutional investments in Indian equities, especially FII have made markets much more efficient compared to what it was 10 – 15 years back. As markets become more efficient, alpha creation becomes more difficult and expenses (TERs) become important. Total Expense Ratios (TERs) of ETFs are much lower than actively managed equity funds. TERs have a direct bearing on return because TERs get adjusted in scheme Net Asset Values (NAVs). The other reason for ETFs popularity is avoiding unsystematic risks, which come into play when active mutual funds try to beat the benchmark index. This is a global phenomenon, which we are seeing playing out in India as well. While retail investments in ETF schemes are rising, the ETF industry AUM is still dominated by institutional investors. In the coming years, we will see an even greater share of retail AUM invested in ETFs.

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