ETF or Exchange traded funds have evolved as a popular and low-cost way to invest worldwide for investors. Particularly for investors who do not want to track individual stocks but are interested in taking exposure to stock market.
What is an Exchange Traded Fund
Exchange traded fund is a freely marketable security which tracks a particular index, commodity, bonds or combination of assets. ETFs are traded on the exchange. Hence their price changes dynamically unlike Mutual funds which have a NAV at the end of the day
Why Exchange traded funds(ETF) are not popular in India
Unlike United states and other developed countries, Exchange traded funds haven’t really taken off in India. There are multiple reasons for the same.
- Relative Underperformance: ETFs have tended to underperform actively managed Mutual funds in India. Which is not the case in markets like US where ETF performance is not very far off from mutual fund performance.
- Lack of choices/Diversification: Investors in India do not have too many choices when it comes to investing in ETFs. Currently, there are limited ETF linked to the index and apart from gold not many commodity ETFs are available in the market. It’s like a typical supply-demand problem, not much quality supply and hence no demand
- Lack of Institutional interest: Few institutions have ETFs on the approved list of investment options. Hence there are few institutions investing in Exchange traded funds.
- Costs are low but not enough: ETFs globally has a low-cost structure in India the cost is little higher. If you add brokerage costs the costs go up further
- Lack of Awareness: Because of low margins, not enough has been done to make ETFs popular amongst investors in India. With distributors not getting any margins, they are not promoting them much
- No additional tax incentives: In US ETFs are more tax efficient than mutual funds. Which is not the case in India.This is primarily because mutual funds and ETFs are treated similarly as far as tax incentives are concerned in India.
- Not enough liquidity: Lack of popularity of ETFs amongst investors results in reduced liquidity as they are traded in the market. Which results in less efficient price discovery and higher spreads for investors. Not the ideal thing to have in a traded asset class.