EXCHANGE TRADED FUND (ETF) vs OPEN ENDED EQUITY MUTUAL FUND

EXCHANGE TRADED FUND (ETF) vs OPEN ENDED EQUITY MUTUAL FUND

Today lots of investment experts and Fund Managers advocating of more Exchange Traded Funds (ETFs ) in Mutual Fund Industry . USA and other developed economies MF industry have a big dominance of various ETFs and many feel India should also be having more and more ETFs . It has got both pros and cons if looked from the perspective of a real ground realities and scenarios .

ETFs are MF product ( portfolio based on any defined basket of securities ) which is listed and traded at the stock exchange like a share . It can be bought and sold on a real time price like share and unlike other MF products which have only one NAV for the day . So it captures features of both MF ( Portfolio ) and share ( tradability on real time price) .

Lets evaluate what risk it poses for investors .

As an investor rather than trading on a particular stock I can trade on basket of similar industry stocks (banking ,IT , Pharma etc ) or similar risk category ( market cap ) or indices ( nifty etc ) . Portfolio is more or less known to me but is portfolio risk i.e short term volatility due to buying and selling of stocks at the stock exchange on real time basis is known to me ? Just like stock the quality does not matter for a day trader but the entry and exit price and timing it at right time matters . Do a normal MF investor has knowledge, information , skills to time entry/exit at right price ?

The downside risk in Equity MF is mitigated by being a long term investor ( > 5 years ) whereas this is more of a short term investment product . If it is to be invested as long term and I wish to bet on market and not on fund management ( active ) then why not go for Index Fund rather than ETF .

Many experts talking of lower cost vis a vis normal MF product . But cost is an irrelevant aspects considering the downside risk from return in short term . Moreover have we factored the taxation side . In Equity MF if any profit booked in the fund it is not taxed . Taxation comes into force only when investor gains by selling the units whereas in ETFs if the investor will be gaining due to impact of same share his taxation will be like normal share . In Equity MF , fund is an intermediary executing trade on behalf of investor so not taxed whereas in ETF there is no intermediary but direct execution by investor so any gain is taxed .

Some talk of easy and quick liquidity vis a vis MF products . But again liquidity at what cost ? Buying and selling behaviour of a day trader can create short term volatility in pricing of the stock and if that stock is in ETF product it will have similar impact . Will it not create more confusion on entry/exit pricing and action as he can not track on real time basis the movements if he is a normal Equity MF investors . Indian stock market and stock prices are mispriced most of times in short term as compared with developed countries and so if a laymen enters in big way in ETF he is infact helping a day trader to gain at his cost . Who knows many promoters can through cartel of stock broker gain through trade inducing a normal investor to fall into their trap .

Its true that today in information age we have access to information on real time basis but again how many of investors have skills to analyse them correctly and most importantly what about the authenticity of the information itself .

I feel ETF is no doubt a very good product and may be future of MF Industry in India but looking at the market mispricing stocks in short term , behaviours of different participants in stock market its not a product which can be positioned as alternative to equity MF but yes can be positioned as an alternative to direct stock trading.

The MF industry should put more emphasis on educating the investors on risk side . The ignorance and lack of knowledge of most investors have to be removed first . Skill sets have to be developed if we want investors to act and behave like a professional fund manager or equity day trader . Pushing a product aggressively to a normal MF investor before that will do more harm than gain for the MF industry .