passive investing with index and etf funds · passive investing with index and etf funds ......

Passive investing with Index and

ETF Funds

The information contained herein is solely for private circulation for reading/understanding of registered advisors/distributors and should not be circulated to

investors/prospective investors.

2

“Don’t look for the needle in the haystack. Just buy the haystack” – John Bogle

Indexing refers to passively investing in the all the constituents of an Index and replicating the

performance of the index as closely as possible.

Indexing provides diversification benefit through exposure to each and every stock in the index

Indexing – An Introduction



Advantages of Indexing include:

Disadvantages of Indexing are as below:

Low cost Diversification Trading at real time NAV in

case of ETFs

Index is based on research

and back tested data

Transparency in holdings

and price

Periodic portfolio

rebalancing

No investor discretion No customisation /

flexibility

No Fund manager

expertise

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Various vehicles available for Indexing in India

Equity ETFs

oMarket capitalisation based

oDisinvestment theme based

oSmart Beta

oSectoral / Thematic

Debt ETFs

oMoney Market

oGilt based

Commodity ETFs

oGold ETFs



I. Index Funds:

"The index fund is a sensible, serviceable method for obtaining the market's rate of return with absolutely

no effort and minimal expense. Index funds eliminate the risks of individual stocks, market sectors and

manager selection, leaving only stock market risk.“ – John Bogle

The first index funds was launched in the year 1975 by Vanguard based on the Index 500 has grown to

over $ 260 billion as on date

II. ETFs:

ETFs are similar to index funds and are actively traded on the exchange. Following are a few types of ETFs

available in India:

III. Fund of Funds investing in ETFs

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Growth of ETFs Globally

Assets under Management (AUM) of ETFs across the globe has grown exponentially from $453 bn

in 2005 to $6,613 bn in March 2019 – a CAGR of over 20%

Data Source: www.etfgi.com. Data as on March 2019. The information contained herein is solely for private circulation for reading/understanding of registered

advisors/distributors and should not be circulated to investors/prospective investors.

http://www.etfgi.com/





Growth of ETFs in India

• Indian ETF industry has seen rapid growth in last 3 years.

• Recent investments in ETFs:

EPFO’s apex decision making body is considering to increase investments in equity ETFs to 15%

of the investible deposits. The major contribution towards AUM of ETFs is by EPFO.

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Data Source: MFI Explorer Data as April 30, 2019. EPFO: Employee Provident Fund Organisation. The information contained herein is solely for private

circulation for reading/understanding of registered advisors/distributors and should not be circulated to investors/prospective investors.

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Concept of Smart Beta ETFs

The Next Big Leap in Fund Management

P/E – Price to Earning Ratio, P/B- Price to Book Ratio, EV/EVIBTA – Enterprise value / Earnings Before Interest Tax Depreciation and amortization, ROIC – Return on

Invested Capital. The above list of factors is illustrative and not exhaustive. The information contained herein is solely for private circulation for

reading/understanding of registered advisors/distributors and should not be circulated to investors/prospective investors.

• Smart Beta ETFs combine both Passive and Active fund management strategies

• Smart beta seeks to move away from market capitalisation- based weighing patterns

• Smart beta seeks to improve returns, reduce risks and enhance diversification by investing in single factors like Volatility,

Value etc. or multiple factors i.e. combination of aforementioned factors.

Factors

Parameters

Data Source

Value

• Low P/E

• Low P/B

• High Div. Yield

• High EV/EBITDA

• Low Price/Sales

Annual Report

Low Volatility

Low Standard

Deviation of Price

Returns

Previous one year

Stock price

Quality

• High ROE

• Low Volatility in

earning surprise

• High ROIC

• Low Debt/Equity

Annual Report

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Assigning weights the Smart Way

Data as on April 30,2019. Source:Niftyindices.com. The information contained herein is solely for private circulation for reading/understanding of registered


Usually assign weights using full market capitalisation method like Nifty 50 Index. Higher the market cap of stocks ,

higher is the weightage of such stocks

Smart Beta Indices assign weight based on relevant factors. For e.g. Low Volatility index assigns weight based on the

below formula: Weight = [(1/ Volatility)/ sum (1/ Volatility)]

Below is the list of Top 5 constituents:

Nifty 50 Index Nifty 100 Low Volatility 30 Index

Less volatile stock gets

higher weightage

High volatile stock gets lower

weightage

Security Volatility (Risk) Weight

A 10.2 4.2%

B 13.4 3.2%

C 16.0 2.7%

D 19.8 2.2%

E 22.0 1.9%

. . .

Company Weight (%)

HDFC Bank Ltd. 5.1

ITC Ltd. 4.0

Hindustan Unilever Ltd. 3.9

Wipro Ltd. 3.9

NTPC Ltd. 3.9

Company Weight (%)

HDFC Bank Ltd. 11.0

Reliance Industries Ltd. 10.0

HDFC 7.0

Infosys Ltd. 6.0

ICICI Bank Ltd. 6.0

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Performance of Smart Beta Indices

Low volatility = Nifty 100 Low Volatility 30 Index, Value = Nifty 50 value 20 Index, Quality=Nifty 100 Quality 30 Index, Multi factor = NIFTY Alpha Quality Low

Volatility 30. Data as on April 30,2019. Source: Niftyindices.com. Index variant considered is Total Return Index variant. Past performance may or may not be

sustained in the future. The information contained herein is solely for private circulation for reading/understanding of registered advisors/distributors and should

not be circulated to investors/prospective investors.

Below graph depicts that use of multiple factors strategy has resulted in better returns over the last decade.

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Low Volatility Value Quality Multi Factor Nifty 50

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Growth of Smart Beta ETFs Globally

Data Source: Internal. Data as on December 2018. The information contained herein is solely for private circulation for reading/understanding of

registered advisors/distributors and should not be circulated to investors/prospective investors.

US $ 800 bn – Asset Size of Smart Beta equity ETFs globally as of December 2018

Assets under Management (AUM) of Smart Beta ETFs across the globe has grown eight fold from

$100 bn in 2008 to $800 bn in 2019 at a CAGR of ~21%

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Smart Beta ETFs AUM ($ Billion)

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“The trick is not to pick the right company. The trick is to essentially buy all the big companies

through the S&P 500 and to do it consistently.” – Warren Buffett

Passive investing allows investors to take exposure to all the constituents in the underlying

index and diversify their portfolio

Passive Funds follows a predetermined strategy irrespective of the market dynamics which

limits the overall churn of the portfolio

No emphasis has to be laid on the past performance of the passive fund as it tracks the

underlying index

It has been witnessed that passive investing has generally done well over a long period of time

A meaningful allocation towards passive funds will help investor generate closer to market

returns for such allocation along with the return generated by allocation to Active Funds

Passive investing as a part of overall portfolio



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Passive Investing can be used as a strategic allocation tool as part of the overall portfolio to generate positive investment

experience for the investor. Below are a few illustration for the same:

Strategy 1 Strategy 2 Strategy 3

Performance of various strategies over the long run

Passive Investing – A tool for Strategic Allocation

Source: MFI explorer. Data as on May 14, 2019. Past performance may or may not be sustained in future. The information contained herein is solely for private

circulation for reading/understanding of registered advisors/distributors and should not be circulated to investors/prospective investors.

60.0%

30.0%

10.0%

Nifty 50 TRI Nifty 100 Low Volatility 30 TRI S&P BSE MidCap Select Index TRI

50.0%

35.0%

15.0%

50.0% 50.0%

Nifty 50 Value 20 TRI

Portfolio

1 Year

(% CAGR)

3 Years

(% CAGR)

5 Years

(% CAGR)

10 Years

(% CAGR)

Active Funds 0.7 11.4 11.3 14.4

Strategy 1 2.7 13.6 12.2 15.3

Strategy 2 1.8 13.3 12.6 15.8

Strategy 3 7.0 15.1 12.9 18.0

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Tactical allocation is the practice of fine-tuning an investment portfolio to meet changing market conditions.

Tactical allocation can be made to various Equity ETFs to benefit from the performance of different indices at different

points of time

Gold as a precious metal has done exceptionally well during certain periods in the past. Gold acts as a natural hedge

against falling equity markets and allocation can be made to Gold ETFs in such a scenario.

Advisors can also advise to allocate to Liquid . Benefits / use case of investing in Liquid ETFs include:

o Short term parking of funds

o Can be used for matching trades

o Can be provided as margin with applicable haircuts.

Passive Investing – A tool for Tactical Allocation &

Operational Ease

The above list is indicative and not exhaustive. The information contained herein is solely for private circulation for reading/understanding of registered


Exposure to 500 stocks

i.e. 95% of listed

universe

S&P BSE 500 / Nifty 500

Exposure to large caps

S&P BSE Sensex/Nifty

50/Nifty Next 50/Nifty

100

Exposure to mid caps

Nifty Midcap 150/ S&P

BSE

Exposure to smart beta

ETFs

Nifty 100 low Vol 30 /

Nifty 50 Value 20

Exposure to

disinvestment theme

ETFs

S&P BSE Bharat 22 /

Nifty CPSE

Exposure to specific

sectors/theme

Nifty Bank / Nifty

Private Bank

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Exchange Traded Funds are traded on the exchange at real-time NAVs. Trading on the exchange means ETFs entail a

certain transaction cost. Below is an Illustration on the costs involved in ownership of Nifty ETF:

The ownership cost per year reduces substantially as the holding period increases, as brokerage and other allied charges

are incurred only on sale and purchase.

Hence, holding ETFs for long term is a better proposition for the investors.

Cost of ownership of an ETF

The above is for Illustrative purpose only. The information contained herein is solely for private circulation for reading/understanding of registered


Particulars

1 year

Expense (bps)

3 years

Expense (bps)

5 years

Expense (bps)

TER disclosed in the fact sheet 5 15 25

Demat charges 1 3 5

Brokerage on buying an selling

(assumed 10 bps each side) 20 20 20

GST on brokerage 3.6 3.6 3.6

Spread on exchange counter

(assumed 5 bps each side) 10 10 10

Total cost of ownership per year 39.6 17.2 12.7

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To Sum it up…..



Passive investing through Index Funds and ETFs has reaped rewards for long term investors

As a result, index funds and ETFs have attracted investor attention and grown in their AUM size

Passive investing allows investors to diversify their portfolio through exposure to all the stocks

in the Index

Passive investing reduces costs through lower fees, lower transaction charges and lower tax

incidence

Smart Beta ETFs allows a combination of passive and active investing by the use of single or

multiple factors and are the next big leap in fund management globally

Allocating a meaningful portion of the portfolio will help toward creation of a diversified

portfolio while also delivering closer to the market returns in the long run

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Disclosures



Mutual Fund investments are subject to market risks, read all scheme related documents carefully.

Disclaimer: All figures and data given in the document are dated unless stated otherwise. In the preparation of the material contained in this

document, the AMC has used information that is publicly available, including information developed in house Some of the material used in

the document may have been obtained from members/persons other than the AMC and/or its affiliates and which may have been made

available to the AMC and/or to its affiliates. Information gathered and material used in this document is believed to be from reliable sources.

The AMC however does not warrant the accuracy, reasonableness and / or completeness of any information. We have included statements

/ opinions / recommendations in this document, which contain words, or phrases such as “will”, “expect”, “should”, “believe” and similar

expressions or variations of such expressions, that are “forward looking statements”. Actual results may differ materially from those

suggested by the forward looking statements due to risk or uncertainties associated with our expectations with respect to, but not limited

to, exposure to market risks, general economic and political conditions in India and other countries globally, which have an impact on our

services and / or investments, the monetary and interest policies of India, inflation, deflation, unanticipated turbulence in interest rates,

foreign exchange rates, equity prices or other rates or prices etc. The AMC (including its affiliates), the Mutual Fund, the trust and any of its

officers, directors, personnel and employees, shall not liable for any loss, damage of any nature, including but not limited to direct, indirect,

punitive, special, exemplary, consequential, as also any loss of profit in any way arising from the use of this material in any manner. The

recipient alone shall be fully responsible/are liable for any decision taken on this material. Investors are advised to consult their own legal,

tax and financial advisors to determine possible tax, legal and other financial implication or consequence of subscribing to the units of ICICI

Prudential Mutual Fund.

passive investing with index and etf funds · passive investing with index and etf funds ......

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