In an enlightening session with Mr. Sameer Desai and Mr. Hemen Bhatia of Nippon Life India Asset Management Ltd., we gained deep insight into ETFs, its core philosophy, and strategies. From our past article, you may have understood what ETFs essentially is; Characteristic of an ETF is a combination of stocks and Mutual Fund schemes. The underlying portfolio of an Passive ETF is an index, it is constructed to track the index and thus mimic the market.
Best of both worlds:
So what is the difference between ETFs and Stocks or Index Funds?
ETFs are passive funds, it eliminates stock specific risks. No additional risks are involved beyond systemic risks. ETFs have all the characteristics of an Index Fund. Although, unlike ETFs, Index Funds cannot be traded at real-time prices; thus we concur that if an Index Fund could get listed on an exchange that’s precisely what an ETF is. It is designed to mimic the gains of a specific index. The benefit of real-time trading, along with the gains of passive investing is what ETF brings to the table.
“Indexes are eternal and individual stocks are ephemeral”
– Sameer Desai
ETFs are excellent for portfolio building, asset diversification and are good even as long-term investment instruments. There is no single investment instrument that has consistently been top ranking in terms of gains. The winners are constantly changing. This is precisely one of the important factors why asset allocation is important. Different levels of correlation among different asset classes provide the portfolio with an effective hedge.
In a run to achieve alpha, investors are trying to time the market and they are failing to gain even the basic rate of return from the market. There is a large universe of competitors in the market today, it is mathematically impossible for every investor to generate alpha within a specific time frame. Consider it like traveling in a local train, there are a few window seats, in the run for this best seat an individual can’t get the window seat every single time, similarly, not everybody can enjoy the window seat together.
“If outperformers are gold medallists and underperformers are bronze medallists then ETFs are silver medallists by default.”
– Sameer Desai
ETFs are a versatile and excellent tool for right asset allocation. For investors interested in actively managing their portfolio the Core-Satellite approach works well. Here the Core of your portfolio should remain untouched focusing on low-cost and broadly diversified assets. This part of your investments will not be risked in hopes of investing in outperformers. The Satellite part of your portfolio also referred to as ‘fun money’ can be invested in sectors that are likely to outperform the markets. These are riskier investments and must be made keeping your risk appetite in mind. This strategy helps gain long-term growth capital through active portfolio management.
Pointers to help you pick the right ETFs:
- Invest in broad market ETFs like Nifty 50 and Nifty next 50.
- Low correlated assets provide better gains. For example, if one of your indexes is Nifty 50 the other investment should be in an asset like Gold that has a low to negative correlation to Nifty.
- For optimal risk adjusted returns diversify across assets by paying attention to the underlying investments.
- Lower the tracking error, the better the ETF.
- Pick ETFs with higher trading volume which ensures prices are real-time giving you better trading opportunities and higher liquidity.
- Low expense ratio + Low tracking error + High exchange volume = Good opportunity