Introduction
ETF turnover is one of the fastest-growing segments of the Indian mutual fund industry. ETFs are funds that track an index, a commodity, or a basket of assets and trade on the stock exchange like shares. ETFs offer investors a low-cost, diversified, and convenient way to gain exposure to various asset classes and themes.
According to a recent report by the NSE, the value of ETFs traded on the exchange surpassed ₹1 trillion in the first nine months of the financial year 2023–24 (FY24), for the second year in a row. This is more than double the pre-pandemic volumes and reflects the increasing popularity and acceptance of passive investing in India.
In this article, we will explore the factors behind the growth of ETF trading in India, the challenges and opportunities for the industry, and the future prospects of ETFs in the context of the clean energy transition and climate change.
Factors Driving the Growth of ETF turnover Trading in India
The main factor behind the surge in ETF trading in India is the adoption of passive strategies by large institutional investors such as provident fund (PF) trusts, pension funds, and insurance companies. These investors have been mandated by the government and the regulators to invest a certain percentage of their corpus in ETFs tracking the Nifty, the Sensex, or the CPSE indices. This has created a steady and significant demand for ETFs in the market.
Another factor that has boosted ETF trading in India is the underperformance of actively managed funds in recent years. Many active funds have failed to beat their benchmarks or generate alpha for their investors, especially in the large-cap and mid-cap segments. This has prompted many investors to shift to passive funds that offer lower fees, higher transparency, and better tax efficiency.
A third factor that has contributed to the growth of ETF trading in India is the innovation and diversification of the ETF product offerings. Apart from the traditional equity and debt ETFs, the market has seen the launch of several new and niche ETFs that cater to the evolving preferences and needs of investors. These include ETFs based on smart beta, ESG, sectoral, thematic, and international indices. Some of the popular themes include gold, banking, consumption, infrastructure, dividends, and clean energy.
Challenges and Opportunities for the ETF Industry in India
Despite the impressive growth of ETF trading in India, the industry still faces some challenges and limitations that need to be addressed. One of the major challenges is the lack of awareness and education among retail investors about the benefits and risks of ETFs. Many retail investors still prefer to invest in active funds or direct stocks and are not familiar with the concept and mechanics of ETFs. There is a need for more investor education and outreach programs to increase the penetration and adoption of ETFs in the retail segment.
Another challenge that the ETF industry faces in India is the liquidity and marketmaking of the ETFs. Liquidity refers to the ease and speed of buying and selling an ETF in the market, and market making refers to the process of providing bid and ask prices for an ETF by a designated entity. Liquidity and marketmaking are essential for ensuring the efficient functioning and pricing of the ETFs and reducing the tracking error and the premium or discount to the NAV.
However, in India, many ETFs suffer from low liquidity and inadequate marketmaking, especially in the non-equity segments. This affects investor confidence and interest in the ETFs. There is a need for more regulatory and industry initiatives to improve the liquidity and marketmaking of ETFs in India.
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On the other hand, the ETF industry in India also has some opportunities and potential to grow further and create value for investors. One of the opportunities is to tap into the untapped and underserved segments of the market, such as the small-cap, multi-cap, and hybrid ETFs. These segments offer more scope for diversification, risk-adjusted returns, and alpha generation for investors. Another opportunity is to leverage the digital and fintech platforms to increase the accessibility and convenience of investing in ETFs. These platforms can offer robo-advisory, goal-based investing, and fractional investing solutions to investors and make ETFs more attractive and affordable.
Future Prospects of ETFs in the Context of Clean Energy Transition and Climate Change
One of the emerging and promising themes for the ETF industry in India is the clean energy transition and climate change. As the world moves towards a low-carbon and sustainable future, there is a growing demand and opportunity for investing in companies and sectors that are aligned with the environmental, social, and governance (ESG) principles and the Paris Agreement goals.
These include the companies and sectors that are involved in the production, distribution, and consumption of renewable energy, such as solar, wind, hydro, and biofuels, as well as the companies and sectors that provide the technology and infrastructure for the clean energy transition, such as battery storage, electric vehicles, smart grids, and energy efficiency.
ETFs are an ideal vehicle for investing in the clean energy theme, as they offer a diversified, cost-effective, and transparent way to gain exposure to the various aspects and dimensions of the theme. There are already several ETFs available in the global and Indian markets that focus on the clean energy theme, such as the iShares Global Clean Energy ETF, the Invesco Solar ETF, the First Trust NASDAQ Clean Edge Green Energy Index Fund, the SPDR S&P Kensho Clean Power ETF, and the Nippon India ETF Nifty CPSE Bond Plus SDL 2024 Maturity ETF.
These ETFs have delivered impressive returns in the past year, as the clean energy sector has outperformed the broader market amid the recovery from the pandemic and the policy support from governments and regulators.
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The future prospects of the clean energy ETFs are bright, as the clean energy transition and climate change are expected to be the key drivers and themes of the global and Indian economies in the coming years and decades. Clean energy ETFs can offer investors long-term growth potential as well as a positive social and environmental impact. However, investors also need to be aware of the risks and challenges associated with clean-energy ETFs, such as volatility, regulation, competition, and innovation. Investors need to do their due diligence and research before investing in clean energy ETFs and diversify their portfolio across different asset classes and themes.
How does an ETF differ from a mutual fund?
An ETF (exchange-traded fund) and a mutual fund are both types of investment funds that hold a portfolio of securities, such as stocks, bonds, or commodities. Nevertheless, notable distinctions exist between them, including:
Trading and liquidity: ETFs trade on an exchange like stocks, and their prices change throughout the day based on supply and demand. Mutual funds are bought and sold through a fund house at the end of the day at the net asset value (NAV) of the fund.
Cost structure: ETFs typically have lower expense ratios than mutual funds, as they are passively managed and track an index or a basket of assets. Mutual funds may have higher management fees, sales loads, and redemption fees as they are actively managed and aim to outperform the market.
Investment approach: ETFs are usually passively managed, which means they mirror a particular index or asset and offer transparency and lower risk. Mutual funds are usually actively managed, which means fund managers invest in securities based on their analysis and market outlook and offer diversification and the potential for higher returns.
Minimum investment: ETFs allow investors to start with smaller amounts, as they only need to buy one share of the ETF. Mutual funds typically require a higher minimum investment, as they are priced in dollars and not in shares.
Taxation: ETFs are more tax-efficient than mutual funds, as they have a lower capital gains tax and fewer taxable events. Mutual funds are less tax-efficient as they may distribute capital gains and dividends to investors, which are taxable.
What are some of the most popular ETFs in India?
Some of the popular ETFs in India are:
Nippon ETF Nifty 100: This ETF tracks the performance of the Nifty 100 index, which consists of the top 100 companies by market capitalization in India. It offers exposure to a diversified portfolio of large-cap and mid-cap stocks across various sectors. It has an expense ratio of 0.1% and a one-year return of 26.63%.
Motilal Oswal NASDAQ 100 ETF: This ETF tracks the performance of the NASDAQ 100 index, which consists of the 100 largest non-financial companies listed on the NASDAQ stock exchange in the US. It offers exposure to some of the leading global companies in the technology, consumer, and healthcare sectors. It has an expense ratio of 0.58% and a one-year return of -3.71%.
CPSE ETF: This ETF tracks the performance of the CPSE index, which consists of 11 public sector enterprises (PSEs) that are majority-owned by the government of India. It offers exposure to some of the dominant and profitable PSEs in the energy, mining, and finance sectors. It has an expense ratio of 0.0095% and a one-year return of 113.05%.
Kotak Gold ETF: This ETF tracks the performance of the domestic prices of gold. It offers exposure to physical gold as an asset class, which can act as a hedge against inflation, currency depreciation, and market volatility. It has an expense ratio of 0.55% and a one-year return of 13.82%.
Nippon ETF Hang Seng BeES: This ETF tracks the performance of the Hang Seng index, which consists of the 50 largest and most liquid companies listed on the Hong Kong stock exchange. It offers exposure to the Chinese and Hong Kong markets, which are among the fastest-growing economies in the world. It has an expense ratio of 0.93% and a one-year return of -4.08%.
Conclusion
ETFs are one of the most popular and dynamic segments of the Indian mutual fund industry and have witnessed remarkable growth in the past few years. The growth of ETF trading in India is driven by the demand from institutional investors, the underperformance of active funds, and the innovation and diversification of the ETF product offerings. The ETF industry in India also faces some challenges and limitations, such as the lack of awareness and education among retail investors, the liquidity and marketmaking of the ETFs, and the competition from other investment products.
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The ETF industry in India also has some opportunities and potential to grow further and create value for investors, such as the untapped and underserved segments of the market, the digital and fintech platforms, and the clean energy transition and climate change themes. ETFs are an attractive and convenient way to invest in the various asset classes and themes, and they can offer investors low-cost, diversified, and transparent exposure to the market.
However, investors also need to be careful and prudent while investing in ETFs and understand the benefits and risks of the ETFs, as well as the suitability and compatibility of the ETFs with their investment goals and risk appetite.
