Primer on Exchange Traded Funds (ETFs) and Mutual Funds

PersonalFn has an article they take a look at what an ETF is and how it is different from Mutual Funds.

In India, the first ETF was Benchmark's Nifty BeES, listed in 2001. Not yet popular because of the demat requirement and also the fact that no agent this product.

But for a disciplined, long term investor, I recommend ETFs all the time. Reason 1: Low cost structure, Reason 2: As good a return as the benchmarks (Nifty in the Benchmark's BeES)

Read the entire article on my website

Annual Fee/Cost & Returns for ETF

Knowledge@Wharton has an article on ETFs

Here are some numbers from the article:

While the average actively managed mutual fund charges investors annual fees of about 1.3% of the amount invested, the Vanguard S&P 500 fund charges just 0.18%. Spyders charge just 0.08%. If the market's annual return averaged 8% a year for 20 years, every $100 invested would grow to $459 in the Spyder, $451 in the Vanguard fund and $366 in the managed fund. The difference: fees' effect on compounding. While managed funds try to offset this disadvantage with good stock picks, many studies have shown that the average manager cannot do this consistently.

We have a few ETFs in India. But the lowest fee is arounf 0.45% compared to 0.08% for the first ETF of the US.

India's first online weekly on personal finance

Comparison Chart of ETFs in India

The Scott Adams unified theory says that invest 70% of your money in a stock index fund and 30% in a bond fund through any discount broker and never touch it until retirement. Let's check out some important data on expenses and return for the ETFs available in India

ETF Report as on November 24, 2007
Scheme Name	NAV (23-Nov-2007)	Expense Ratio (30-09-07)	Simple Annualised Return (%)
			1 Year	3 Years	Since Inception
Bank BeES	899.50	0.55	44.5	69.2	72.9
Gold BeES	1043.49	1	--	--	14.5
ICICI SENSEX Prudential ETF	192.92	0.8	37.4	71.2	97.4
Junior BeES	111.39	1	54.8	63.1	110.2
Kotak Gold ETF	1046.57	--	--	--	53.1
Liquid BeES	1000.00	0.7	0.0	0.0	0.0
Nifty BeES	567.06	0.8	40.8	64.5	75.0
PSU Bank BeES	293.74	--	--	--	34522.1
Reliance Gold ETF - Dividend	1039.70	--	--	--	15590.5
Reliance Gold ETF - Growth	--	--	--	--	--
UTI's SUNDER	575.53	0.5	43.5	66.3	108.5
UTI Gold ETF	1045.28	--	--	--	6.6
Indices
S&P Nifty	5608.60		42.1	64.9
BSE Sensex	18852.87		37.7	70.8
Crisil Liquid Fund Index	1348.40		7.3	6.3
BSE PSU	9502.09		51.2	48.2
CNX Nifty Junior	10949.10		55.0	62.5

Source and thanks to Sunita Pawar, Customer Care Manager, Bench Mark Mutual Funds for the immediate response to our email

The birth of the Mutual Fund with no distributors

Quantum Mutual Fund uses the internet and word of mouth to bring more business.

The story behind Quantum Mutual goes back to late 2005, when
after getting permission from Sebi to start his own AMC, Ajit Dayal met several distributors to create awareness about his funds. But he was shocked to see them put forth ‘a pricing sheet’. For 6% commission, you’ll get Rs 6,000 crore, for 5%, Rs 500 crore and so on, distributors told him.

“Without bothering to check whether a product is suitable for
investors, they came up with a sliding fee structure,” reminisces Mr Dayal, who is one of the first stock analysts and investment managers of the post 1991 era. “But who is going to pay for all this?” he asked them. The last straw came when Mr Dayal went to a senior broker and asked him to recommend his funds to investors, but refused to pay him the hefty commission that he demanded. “We make elephants in the industry dance to our tune, you are just an ant,” thundered the broker. The decision was made.

Read the full story on the ethical Mutual Fund in Economic Times

ETF is Smarter than the Smart Fund Managers

Nilanjan Dey has a useful and informative article on Index funds in Business Line. He writes about ETFs and how they have outperformed actively managed funds in the last fiscal year. He asks some very relevant questions about investing. Go to the article

Even though the actively managed funds have done better on a 3/5 year scale, the net difference would be lower or non existent because of the higher cost. The active funds charge you 2-2.5% while the ETFs charge around 0.5% only. The extra Fund management charges will even out the difference, I guess.

I wonder why a good product like index funds does not sell like hot cakes. Comparatively an expensive product like ULIP is selling like hot cakes even though it is much more expensive than the MFs??!!

I guess it boils down to lack of knowledge/information and that the agents have no interest in selling them.

Reviews, Tips, Calculators with an Indian perspective.

Common Sense Investing Book by Bogle

The Little Book of Common Sense Investing is an amazing book by John Bogle. Read this about the book you can buy on Amazon

Investing is all about common sense. Owning a diversified portfolio of stocks and holding it for the long term is a winner’s game. Trying to beat the stock market is theoretically a zero-sum game (for every winner, there must be a loser), but after the substantial costs of investing are deducted, it becomes a loser’s game. Common sense tells us—and history confirms—that the simplest and most efficient investment strategy is to buy and hold all of the nation’s publicly held businesses at very low cost. The classic index fund that owns this market portfolio is the only investment that guarantees you with your fair share of stock market returns.

To learn how to make index investing work for you, there’s no better mentor than legendary mutual fund industry veteran John C। Bogle. Over the course of his long career, Bogle—founder of the Vanguard Group and creator of the world’s first index mutual fund—has relied primarily on index investing to help Vanguard’s clients build substantial wealth. Now, with The Little Book of Common Sense Investing, he wants to help you do the same.

Some excerpts from the book:

• Index funds eliminate the risks of individual stocks, market sectors, and manager selection. Only stock market risk remains.
• Don't allow a winners game to become a loser's game.
• Fund investors are confident they can easily select superior fund managers. They are wrong.
• The stock market is a giant distraction.
• If the data do not prove that indexing wins, well, the data are wrong.
• It's amazing how difficult it is for a man to understand something if he's paid a small fortune not to understand it.
• The miracle of compounding returns is overwhelmed by the tyranny of compounding costs.

Reviews, Tips, Calculators with an Indian perspective.

Index Funds Outsmart Fund Managers

Another fact which makes me champion ETFs:

Returns generated by actively managed equity funds will close the year with a growth of around 10%. While the Index funds or ETFs have offered a growth of 19.57 % for the same period. (Source: ValueResearch)

So why do we pay for the extra fund management charges by around 2%?

The major reason for ETFs not being popular is that the agent does not want to sell a product where he is not getting a good commission.


Reviews, Tips, Calculators with an Indian perspective.

How to Add Value To Your Money

Some readers are asking me about where to invest. I have been guarded with my answers and try to evade with the observation that since everyone has different financial goals and risk appetite and so my recommendations may not work for him/her.

But when my elder brother asked me the question, I did not have an escape route. And a responsibility too. After all I can't vanish from him after a year or so!! ;)

Btw, it's also important to note that this elder brother is an IIT(D)/IIM(A) guy and can't be taken for a ride! And also that the IIT/IIM guys also need proper financial advice!!

Let's take a look at some of the popular options available which are Bonds, Stocks, Real Estate, Mutual Funds, Unit Linked Insurance Policy (ULIP) and Exchange Traded Funds (ETF). Now I'll try to rate them on four parameters of investing. i.e. 1. Growth, 2. Liquidity , 3. Security and 4. Expenses

1. Growth: Stocks MFs and ETFs top the rankings here. Over a period of over 5 years, the CAGR is above 15% in comparison to 8% in Bonds. ULIPs begin to give a good growth only after 5 years or so because initially they are very expensive. Real estate is on a fairy run these days too.
2. Liquidity: Again, Stocks, MFs and ETFs score heavily while Bonds and ULIPs have a lock in period or have substantial surrender charges. Real estate scores low here (u have to be lucky to get good buyers at the right time)
3. Security: I would rate all of them at par over a long term of over 5 years. But you may get into a bad stock or real estate which are totally unsecured. Otherwise too, stocks and real estate are very volatile and can affect your blood pressure too!!
4. Expenses: ETF is the least expensive with charges of around 0.5% compared to 2% from MFs and much more in ULIPs (especially in the initial years). Stocks too are the least expensive provided you get into the right stocks at the right time.

Based on this short analysis, I would recommend ETFs. Read more about ETFs here. But as I said earlier too, one man's meat could be another man's poison. Moreover the diversification rule says that one should not keep all your eggs/ apples (for the veggy!!) in one basket. So let us take a look at the investment options, one at a time.

• Shares: Investing in the equity market directly is exciting and sexy. You are in the thick of things and learn many things in the process. Though the volatility and the information overload makes it a daunting task, investing in stocks is not rocket science. You can start with identifying a list of 10-15 companies out of 3-5 sectors which you know or which interests you. You can keep a tab on their management team, financials and future outlook and over a period of time, you will be able to take a call on them.
• Real Estate: I feel that one has to be plain lucky to get into a good deal and be able to get the right buyer at the right price and time. I can't think of any other factor other than luck. So if you feel , you are blessed and have the right tip, go for it. Otherwise, it's a no no.
• Mutual Funds: One should allocate time to investment decisions in proportion to our income generation goals. Also convenience and hassle free investing should be a major factor. Mutual Funds fit the bill where Fund Managers are into it full time. If you are able to identify fund managers who have consistently performed over last 3-5 years, nothing like it. The fund manager also has the muscle power of crores of Rupees and is able to take entry and exit decisions impartially. MFs continuously churn their portfolio. When MFs buy and sell stocks, they don't have to pay capital gains as you do when you churn. With Systematic Investment plans (SIP), you can start investing with as low as Rs 500 per month. But MFs have its own loading and administrative charges and the fund managers make merry on your hard earned money.
• Exchange Traded Funds: While the index fund has given a one-year return of 42%, diversified equity schemes (MF) could only come up with 34% returns. Diversified equity funds usually have large expense ratios compared to index funds. For example, the expense ratio of Banking BeES, an index fund, is only 0.45, while it is anywhere between 2-2.50% for diversified equity schemes. That's why I recommend ETFs.
• ULIPs: Unit linked insurance policies combine two products, i.e. Insurance and Mutual Funds. In the initial few years, ULIPs are damn expensive. But in case you don't want any hassles of investing, you have a tried and tested Insurance agent who is almost part of your family then ULIPs are for you.
• Bonds: For those of you who are risk averse.

U can also read more on Mutual Fund, Equities, ULIPs.

Your comments help me in arranging my thoughts in a better way. I would like to post more detailed analysis on each of these and also spell out the steps to be taken.

Interested? Why don't you subscribe to my posts by email or RSS feeds

Reviews, Tips, Calculators with an Indian perspective.

Gold Exchange Traded Funds

PersonalFn guys have a detailed review of Gold ETF which has been launched by Benchmark MF and being launched by UTI MF in March,2007 See their detailed review here

Some facts extracted from the review about gold:

Gold as an investment avenue has in some sense failed to deliver over the long-term. In fact, over the last 17 years, gold has appreciated by only 8.6% CAGR - Compounded Annualised Growth Rate. This compares not so well with other investment avenues like the stock markets (the return from the BSE Sensex over the same period is about two times more than what gold has delivered).

Gold is considered to be a safeguard against inflation. The reason for this is that the factors that affect the price of gold are usually different from factors that impact prices of financial assets like stock markets and bonds. So in times when financial assets are in turmoil due to inflation or any other development, the price of gold will tend to move in the other direction and money flows into 'safe' assets like gold. In a portfolio, gold brings in much needed stability over the long-term.

Given the relatively high entry load(1.5%) charged by the fund house during the NFO period, investors, who intend investing in gold, should avoid Gold BeES during the NFO period. They can consider investing in the ETF after the NFO period when it gets listed in the stock exchange (broker charges 0.5%).

Reviews, Tips, Calculators with an Indian perspective.

Index funds beat stock pickers

While the index fund has given a one-year return of 42%, diversified equity schemes could only come up with 34% returns. Ditto for tax planning schemes, traditionally strong performers, which are lagging the sensex with 30% annual returns. Only information technology sector funds performed better (52%) than the index funds.

However, that is no reason for fund mangers to rejoice as it is not their stock picking skills that propped up the returns, but the brilliant performance of the entire sector.

It is quite funny. These funds charge fund managing fee to actively manage the corpus to outdo the indices. But look at the result. I feel that I would have been better off with an index fund. I would have saved some expenses too.

Diversified equity funds usually have large expense ratios compared to index funds. For example, the expense ratio of Banking BeES, an index fund, is only 0.45, while it is anywhere between 2-2.50% for diversified equity schemes.

Index funds are simple to understand. They are transparent, as you know which are the stocks you are getting into. You are not dependent on the stock picking skills of the fund manager. It is also easy to measure the performance of these schemes.

Index funds are especially suited for those who don’t know much about the stock market and are investing for the first time.

Read more about ETFs here and here

KISS while Investing.

Simplify your Life.

Unless you're working full-time in the financial world, you don't have the skills, tools, information, time or interest in playing the market. In fact, even the hotshots working full-time in the financial world follow the same strategy with the bulk of their assets. It's their biggest secret.

Mutual fund managers who are playing the market with your money, often lock away the bulk of their retirement assets in safe, untouchable portfolios. Well, they've got families to protect too.

So what is this laidback investing? Simple, well-diversified portfolios of a few no-load index funds, either mutual funds or ETFs. Least expensive and no tracking troubles!

Keep it Simple, Stupid. It's the KISS strategy!

Buy Gold On Paper

Yes, The Gold ETF is coming.

The Securities and Exchange Board of India (Sebi) today cleared the draft applications filed by Benchmark and UTI Mutual Fund for launching gold exchange-traded funds, nearly eight months after the fund houses filed their draft application with the regulator.

Instead of actually trading or buying and selling real gold, GETFs, are basically an investment in certificates backed by gold.Based on the price of 1/10th (usually) of an ounce, ETF or ‘Gold-linked shares’ are traded on popular bourses.

Total trading in NYSE has been said to be close to $3.3bn in assets in ’05. NYSE remains the largest exchange to attract investors in gold ETF segment. Apart from the New York Stock Exchange (NYSE) in the US, gold ETF is also traded in bourses located in Australia, UK, South Africa , France and soon India.

Gold shares are apparently intended to offer investors a means of participating in the gold bullion market without the necessity of taking physical delivery of gold, and to buy and sell that interest through the trading of a security on a regulated stock exchange. This introduction of Gold shares is supposed to lower many of the barriers, such as access, custody, and transaction costs, that have prevented some investors from investing in gold.

What is an ETF? Ask or Index Funds beat Stocks or What is ETF

I will still be keeping my value in real gold that you can hold and feel in your hands! Oops! My wife hands, ofcourse!!

Index funds beat stock pickers

Bloomberg reports that the $14 billion iShares MSCI Emerging market index, the largest exchange traded fund (ETF) beat those that are actively managed.

Think of an exchange-traded fund as a mutual fund that trades like a stock. Just like an index fund, an ETF represents a basket of stocks that reflect an index such as the Nifty. An ETF, however, isn't a mutual fund; it trades just like any other company on a stock exchange. Unlike a mutual fund that has its net-asset value (NAV) calculated at the end of each trading day, an ETF's price changes throughout the day, fluctuating with supply and demand.

It is important to remember that while ETFs attempt to replicate the return on
indexes, there is no guarantee that they will do so exactly. By owning an ETF, you get the diversification of an index fund plus the flexibility of a stock. Because, ETFs trade like stocks, you can short sell them, buy them on margin and purchase as little as one share. Another advantage is that the expense ratios of most ETFs are lower than that of the average mutual fund. When buying and selling ETFs, you pay your broker the same commission that you'd pay on any regular trade.

There are various ETFs available in India, such as:

NIFTY BeES: An ETF launched by Benchmark Mutual Fund in January 2002.

Junior BeES: An ETF on CNX Nifty Junior,launched by Benchmark MF in Feb, 2003.

SUNDER: An Exchange Traded Fund launched by UTI in July 2003.

Liquid BeES: An Exchange Traded Fund launched by Benchmark Mutual Fund in July 2003.

Bank BeES: An ETF launched by Benchmark Mutual Fund in May 2004.

Exchange Traded Funds (ETF)

Basically, ETFs are open-ended index fund that can also be traded on the stock market.

Compared to Mutual funds, there are many advantages of ETFs, one is real time pricing, secondly long term investors are protected from short term traders. Hence it proves to be an ideal instrument for both long term as well as short term investors and also it is easy to buy and sell from the exchange. One major disadvantage of ETF is that the investor should have a demat account and a broking account.

There are two types of advantages over index funds - one is the expense ratio which is currently lower in ETFs as compared to normal index funds. The second advantage is the distribution costs- the other index funds have to pay trail commission to the broker, while ETF does not pay the same. So the ETF cost will be lower.

In addition to the above-mentioned expenses, there also exist some `hidden' costs like transaction costs. Such costs do not form a part of the expense ratio like brokerage and STT. The transaction costs however, are incurred by index funds but not by ETFs. This is another area where ETFs score over regular index funds.

ETFs don't incentivise their product, which other regular mutual funds can do, hence there is no one pushing it.

But internationally what has happened that over a period of time people have found out that ETFs are ideal instruments and it has become more popular.

Just to give an example - in the last three month if you look at the Nifty BeES, among all forty funds it was ranked 11th in the down market, which clearly shows that the ETFs/index funds are working.

Thanks to Personal Fn.com interview of Mr. Rajan Mehta who is the Executive Director of Benchmark Asset Management Company Pvt. Ltd