“The index methodology throws light on not only how the underlying portfolio is created but also how and when the portfolio will be reconstituted by including new stocks and/or excluding existing stocks,” says Srivastava, in an interview with ETMarkets. Edited excerpts:
ETFs are built on index and if any stocks in the underlying have major issues, one will have to ride with them. So, how does an investor tackle this?
Before investing in any passive product, it is important that investors spend some time in understanding the underlying index methodology.
The index methodology throws light on not only how the underlying portfolio is created but also how and when the portfolio will be reconstituted by including new stocks and/or excluding existing stocks.
By knowing the same, an investor can choose whether a particular passive product suits his or her investment objective.
Time and again the Indian equity market has witnessed significant drawdowns in particular stocks, despite the broad-based indices having continued their long-term growth.
Even in the case of the sector, theme, or strategy-based index products, where weights are probably more concentrated, indices will undergo scheduled reconstitution keeping the indices up to date on a periodic basis, though depending on the index methodology, the potential risk and reward may vary significantly. Overseas investors are subject to both short-term and long-term capital gains tax when they invest in Indian stocks. Do you think this can discourage investment given the high costs?
The taxation might affect investment decisions which are based on tactical or short-term opportunities.However, in case of Strategic Asset Allocation (SAA) and long-term bets, they do not act as much of a hindrance given the positioning of India in terms of growth.
The relative attractiveness of the various other equity markets also play a key role in determining the allocation and so far India has been well anchored and positioned on that front.
Passive investing has gained a lot of traction in India in the last few years. According to you, what more needs to be done to improve penetration in this segment?
More investor education and awareness initiatives need to be undertaken by the industry especially among non-metro cities to make investors aware about passive investing.
I think distributors and advisors can play a big role by increasing the usage of passive products in client portfolios, especially in order to reduce the cost and active risk.
The phenomenal growth of the DEMAT account will certainly give traction to ETFs, where I think the improvement in liquidity due to the increasing number of investors and a more robust market-making structure will make ETFs more efficient and attract more investors over time.
What kind of passive funds are you currently managing/researching?
We manage a broad basket of passive products, several of which are India’s first.
We have plain vanilla ETFs tracking broad market indices like Nifty 50, Nifty Next 50, and Nifty Midcap 150.
We manage fund of funds that invest in these 3 broad-based ETFs and do allocation based on valuation attractiveness.
In themes, we have products catering to financial services, manufacturing, and ESG.
On the global side, we have ETFs and Fund of funds giving broad-based as well as concentrated exposure to the US market by tracking S&P 500 Top 50 index and NYSE FANG+ Index, respectively.
We also host two globally emerging themes, which are “Artificial Intelligence” and “Electric and Autonomous Vehicles” via the fund of fund route for Indian investors.
In addition to this, on the debt side, we have target maturity index funds product capturing 3-Yr. 5-Yr. and 10-Yr maturity.
In the future, we will continue to bring a blend of plain vanilla and exotic product on both the equity and debt side.
Can you explain the difference between target maturity funds and fixed maturity plans? Which one would be a better option for an investor looking for long-term returns through passive investments?
Target Maturity Funds (TMF) are similar to Fixed Maturity Plan (FMP), both have fixed maturity date, but carry the advantage that the investor has an option to subscribe or redeem anytime during the lifecycle of a target maturity fund which they cannot do in case of an FMP.
Further, as opposed to FMP, where the fund manager has discretion over the underlying portfolio, TMF needs to do investments in accordance with SEBI guidelines to risk replicating the underlying index.
This gives investors comfort in TMF as risk and portfolio behavior is more transparent vis-à-vis FMP. It must be noted that while TMF provides higher yield visibility to the investor at the time of investment, FMP has potentially lower yield leakage.
Do TMFs target only AAA-rated bonds? What are the risk factors taken into consideration in these funds?
Target Maturity Funds can be based on various types of debt instruments including non-AAA bonds. But currently, most of the target maturity funds are based on AAA bonds and/or government securities as managing inflows and outflows in such portfolios is easier and yield leakage is lower.
Notwithstanding the various advantages target maturity funds have to offer, investors should note that TMFs are not principal protection or guaranteed return scheme.
If a TMF invests in non-sovereign securities then it is exposed to credit risk, theoretically. Further, if an investor sells or redeems his/her units before the maturity of the scheme then his/her return may be higher or lower than the indicated Yield to Maturity (YTM) at the time of investment i.e. he/she is exposed to interest rate risk, if not held till maturity.
Lastly, an investor should note that YTM at the time of deployment of fund is relevant indicator of potential return, further, some yield leakage due to expense ratio and cost associated with buying and selling of underlying assets shall be kept in mind before investing in the Target Maturity Product
Post the pandemic, we have seen companies strengthening their balance sheet significantly across large caps and midcaps. Do you think this will give an opportunity to look at investments beyond AAA-rated debt instruments?
What has helped in the wide acceptance of TMF is the yield visibility and providing visibility of the underlying portfolio.
Since TMF is a passive product and it tracks an index, the investor can assess his/her comfort level with the underlying portfolio. This has become critical post-credit default and winding up of certain debt schemes in the country. The investor can be reasonably assured that a TMF tracking an index, comprising AAA PSU bonds, cannot invest in bonds of AA+ rated securities etc.
In terms of target maturity funds, we believe once AMCs are comfortable with the liquidity of the non-AAA portfolio and managing the tracking difference vis-à-vis index, more variety of target maturity funds including based on non-AAA bonds can come to the market.
(Disclaimer: Recommendations, suggestions, views and opinions given by the experts are their own. These do not represent the views of Economic Times)
