‘ETFs in debt have a huge potential for investments’

You ushered in the ETF revolution in India with NiftyBeeS, a Nifty equity ETF, launched in 2001 with Benchmark Mutual Fund. Describe its growth today?

The idea of benchmark stemmed from two philosophies—one, that active management doesn’t work. Today, we have enough research to show that, but even in the early 2000’s active funds were underperforming, we had a couple of research published in the Journal of Indexes showing that. And two, that the intermediary who sells/advises on financial assets including mutual funds should be an agent of the investor and not the AMC (asset management company), her remuneration should come from the investor, then her whole approach to advice would change. It’s sad that it still is work in progress and not fully implemented. We—Rajan Mehta, Sanjay Gaitonde and myself, the co-founders— felt that we needed an AMC which believed in these twin philosophies. ETFs were the right instrument for this as it was an index-linked product and with the vast network of NSE it would have no distribution fees embedded. Today, ETFs are being embraced and we are delighted by the fact that size has grown to more than ₹6 trillion.

Data from DSP Mutual Fund shows the six-month average volume of a large liquid stock like Reliance Industries Ltd (RIL) is ₹1,948 crore vs ₹78 crore volume of Nippon India ETF Nifty 50 BeEs, one of the most liquid equity ETFs in India (4% of RIL). The six-month average volume of Apple is nearly 26.15% of the SPDR S&P500 ETF. What are your suggestions to tackle the liquidity problem in ETFs?

On the NYSE, 5 out of the top 10 traded securities are ETFs. My belief is that the same will happen in Indian markets. As of today, Nifty 50 BeEs, Nifty Next 50 Junior BeEs and Nifty Bank BeEs have high liquidity and one can do decent size of trading. But yes, liquidity is an important factor and needs to be addressed. The concept of market makers like in futures and options (F&Os) would help. And once large institutional players come in as investors, the liquidity issue will be automatically addressed.

India could have been the first country to launch gold ETFs but we lagged behind. Why did that happen? Interestingly, gold ETFs had dominated the ETF space in the beginning. How did the trend transform in subsequent years?

Initially there was a lot of resistance to a new concept. Our markets were not confident or mature enough to take in a completely new idea or product. Maybe there was also under-confidence in our own capabilities among all stakeholders. Yes, Gold ETFs did dominate the ETF space because there was an obvious need for a product where Indians could buy gold as an investment asset in a hassle free manner. The cost of investing in gold was more than 5% and selling also attracted that much or more. Gold BeES brought this down to less than a per cent. With liquidity available on the NSE. It made it very popular. Now we have many more avenues to invest like the gold bonds.

You designed the CPSE ETF while working at Goldman Sachs to pitch it as one of disinvestment tools to the government. A good chunk of Employees’ Provident Fund Organisation (EPFO) money goes into the CPSE ETF (besides Sensex and Nifty ETFs) but the ETF is highly concentrated in the energy sector. Isn’t it concerning given that EPFO promises a fixed rate to subscribers irrespective of how its equity portfolio performs?

CPSE ETF was conceived to include the Specified Undertaking of the Unit Trust of India (SUUTI) stocks and would have been an alternative to an all market index. As the product evolved, it took the shape of an index of the largest CPSE stocks and a way to invest in the largest public sector enterprises. Its success and acceptance can be gauged from the fact that nearly ₹1 trillion has been disinvested through this ETF. EPFO, as I understand, is mostly invested in the Nifty and Sensex ETFs. CPSE would in fact help in terms of diversification. We worked with EPFO a lot to start them investing in equities and limit that to index investing and not active. EPFO has a long-term liability and worldwide we have seen that equities provide a better return over the long-term. We believe that if there was no investment in ETFs by EPFO, the asset liability mismatch would have become a problem.

Should the government consider tax incentives to promote mass interest in ETFs?

No, I am not a fan of tax incentives for just a different structure for the same asset class, however good and advantageous it would be for the investor. I would suggest that the way mutual funds were marketed by the AMFI, a similar exercise should be done for ETFs.

Recently we have seen a few ‘smart beta’ such as equal weight getting launched as ETFs rather than index funds. Do you think these could be useful for investors or should they focus mainly on standard ETFs only?

Data suggests that in the long run, a market based index works the best in terms of risk, returns. Some ideas and concepts work for a certain period of time until all, in a sense, revert to the mean. But if the smart beta products get the investors introduced to index investing and ETF’s, it’s great

What other innovative ETFs can be launched in India to expand the ETF basket?

When we launched Liquid BeES, it was the first in the world, but more importantly it was the first instrument which bypassed the banking system. You could transfer from one demat account to another. So, it is a precursor to wallets, and CBDC, or central bank digital currency. I believe we can have more such ideas waiting to happen. ETFs on debt have huge potential for new and innovative products. Debt ETFs can help create a retail yield curve, corporate ETFs can tap a huge latent demand which used to go to fixed maturity funds. An ETF on AIFs (once their units are dematted) can bring alternative investments to the retail market.

In hindsight, do you feel you exited the MF industry a little bit early to gain from your initial efforts to establish?

We exited the industry in the beginning of 2017 after Goldman. I am very happy to see the growth of the ETFs and mutual funds in general. We introduced a concept and philosophy of investing and executed products based on that. We absolutely have no regrets. In a sense, we did what we set out do and are delighted to see the market embrace this idea.

What is Sanjiv Shah up to now? What new innovation are you working on?

Well, Sanjay and I have co-founded a fintech firm in logistics payments which is also a payment aggregator, one of the first to get in-principle approval from the RBI. We also have given a proposal for setting up a prediction market platform to the Sebi. We are also contemplating some ideas in the banking space.

How do you manage your own money? What is your asset allocation mix and in which products have you invested?

Simple. it is two-thirds equity, one-third debt. All equity (besides in our ventures) in Nifty, Sensex and Nifty Next 50. Debt is a mix of tax-free bonds, RBI deposits and mutual funds.