You may be wondering why Kotak AMC – a fund house known for its actively managed funds – is talking to you about exchange traded funds (ETFs) – which are passively managed and only track indices rather than aspire to beat them.  There are a few reasons why we believe that ETFs are at an inflection point in India and why they may become increasingly relevant for financial advisors. Over time, in addition to being known for our actively managed funds, we would also like to be known as a firm that offers a wide range of ETFs to investors and advisors who have a preference for that route to take an exposure to markets.

Globally a big and rapidly growing segment

Globally, ETFs are a large and growing category.  The first ETF opened for business some 15 years ago in USA – the SPDRs which mirrored the underlying S&P500 was the first Exchange Traded Funds launched in the world.

Today, we have over 1800 ETFs across the world, with AuM in excess of US$ 900 Bn. To put that number in perspective, its as large as the Indian banking industry – which is close to around Rs. 40 lakh crores today.  US is the largest market for ETFs – with a market share of about 70% of all ETF AuM. Next in line is Europe, which accounts for about 22% of worldwide ETF AuM. Japan comes third in world market share for ETFs.

Morgan Stanley estimates that the worldwide AuM of ETFs is likely to double to US$ 2 trillion in just two years. Uncertainities in global markets and a consequently stronger focus on costs are seen as catalysts that will drive growth of this sector. 

Institutional interest is a big driver

One of the biggest drivers of growth in ETFs is institutional interest in this segment. Hedge funds, pension funds, insurance funds and other forms of institutional investors – who have large volumes and a very strong focus on costs – are the biggest investors in ETFs.  In fact, one third of all institutional money that’s invested in various markets is invested passively – through ETFs and index funds.

In 2000, ETFs represented only 1% of global AuM of the MF industry. That has grown to about 8% now.  The other key factor to keep in mind is that through this entire financial meltdown and global scare, the only segment of the fund industry that continued to register positive net flows was the ETF sector.

In India, though the ETF sector is still at a very nascent stage, we did see through 2008 and 2009 that while actively managed funds at an industry level saw net outflows, the ETF sector managed to record positive net flows.

Retail participation in India in ETFs is still very low – but in US, about 50% of mutual fund investors have ETFs in their portfolios.  In mature markets like US, where it is increasingly becoming difficult to outperform benchmarks, many investors seem to prefer the lower cost, benchmark tracking ETFs as a means to taking an exposure to markets.

A great way for first time investors to participate in equity markets

The other driver for ETFs – which is perhaps more relevant in markets like India – is to use them as a vehicle to introduce investors to equity as an asset class. Once investors get comfortable with the asset class using passive and lower risk products like ETFs, advisors can graduate their clients into actively managed funds – that aspire to beat benchmarks – but which also carry an incremental level of risk as a consequence.

ETFs in India have been around for about 6 years. They are still at a very early stage of development. Out of the 37-38 fund houses, only 7 have ETFs in their portfolios. There are around 18 ETF products today with a cumulative AuM of around Rs. 2000 crores – less than 0.5% of industry AuM.

So why are we as a fund house promoting ETFs?  The key here is that we are not promoting only ETFs – we are also promoting ETFs.  The main reason we are keen on propagating ETFs is that we believe this category can help drive mutual fund penetration in a market that is yet seriously underpenetrated.  For first time investors into equity markets, this is a good place to start – they know what the upside and downside will be – the beta is always 1. The lower costs, product simplicity, transaction execution convenience and lower risk profile – all combine to make this a useful product for advisors and distributors to use in order to promote and spread the equity cult among first time investors.

Kotak Sensex ETF : a must buy for any first time equity investor

Many investors can identify with the Sensex. If they are bullish on the market, they can simply buy the Kotak Sensex ETF – which mirrors the Sensex.  That’s an index that most retail investors relate to and track. The ETF’s price will be 1/100th the Sensex level – ie, if the Sensex is at 16,000 an investor knows that his purchase price will be Rs. 160. Tracking the price and relating it to the Sensex will be very easy for first time investors. We believe this is a great way to get an investor started into equities.

Gold ETFs : growing rapidly, bright prospects ahead

Out of the Rs. 2000 crores of industry AuM for the ETF category, around Rs. 1000 crores is gold ETFs.  Gold ETFs are becoming increasingly popular and more and more advisors – especially in the no load environment and with the bullishness on gold – are allocating 5% to 10% of client portfolios to gold ETFs.  Indians have always been investing in gold. With the ETFs, investors now have a very convenient, cost effective and safe way to invest in their favourite asset class.

To conclude….

We are a serious player in the ETF segment – we believe that in the long run this segment will become increasingly relevant for investors and advisors and will become a material part of investors portfolios.