ETF assets surge four-fold in 2 years on steady inflow from EPFO

The assets of exchange-traded funds (ETFs) have quadrupled in the past two years, on the back of steady inflow from the Employees Provident Fund Organisation (EPFO).

ETFs are traded on stock exchanges, with stocks, bonds or commodities as the underlying product. An ETF's portfolio exactly mimics the securities in its underlying index, in the same weightage.

EPFO had entered the stock market in August 2015. The decision was to invest up to five per cent of its investible deposits; this was raised in 2016 to 10 per cent and then in 2017 to 15 per cent. The body had an estimated Rs 440 billion invested in the stock market this January.

EPFO has invested the remaining portion in debt market instruments such as government securities and bank fixed deposits.

ETF schemes run by SBI Mutual Fund and UTI MF have cornered most of the EPFO inflow; the former got three-fourth, it is estimated. Experts believe interest in the ETF space is likely to increase as liquidity improves and participation from cost-conscious institutional investors sees a surge.

"ETFs offer two distinct advantages.

One, fund manager risk is taken out of the equation. Two, the charges are much lower compared to active equity funds," said Suresh Sadagopan, a financial planner.

According to estimates, ETFs charge 0.2-0.5 per cent on average, compared with 2-2.2 per cent by actively managed diversified equity funds.

Going forward, ETFs might also benefit from recent regulatory changes. With the benchmarking of the returns of equity schemes against a total returns index (TRI), instead of a simple price return index, the overall alpha (measure of excess return) for equity schemes, especially large-cap funds, could get substantially impacted. The introduction of TRI is expected to shave off 1.25-2 per cent (the average annual dividend yield for Indian equities) from the returns of equity schemes.

The regulator has also tightened the definition of what constitutes a large-cap, mid-cap, small-cap and multi-cap fund. This means fund managers will no longer be able to change styles, known in sector parlance as 'style drift', simply to add to the returns. All this could somewhat reduce the attractiveness of actively managed large-cap funds and push investors towards passive products such as ETFs.

Interestingly, while the assets of equity ETFs have surged, those of gold ETFs have dipped 19 per cent to Rs 49.1 billion over the past two years.

"Gold has not given returns since 2011 or so, and investors are not keen on staying invested," said Sadagopan.