Edelweiss converts two ETFs to index funds: Here's what investors must know

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Edelweiss mutual fund has converted two of its equity exchange-traded funds (ETFs) to index schemes. It has changed its Nifty 50 ETF to a Nifty 50 index fund and its Nifty 100 Quality 30 ETF to a Nifty 100 Quality 30 index fund. These changes will be effective from October 7. It has given a month’s time to investors for switching out of these funds, if they do not approve of these changes, as per the exit option rules.

Low liquidity

Worldwide, ETFs have become popular because active funds have found it tougher to beat their benchmark indices. ETFs mimic the benchmark indices, so it’s easier for fund houses to retain investors through the bad times, given that any decline in value is in line with those of the benchmark. Some actively-managed funds could decline way more.

ETFs come with low costs, which is a key reason behind their rising popularity.

The flipside of ETFs is that they lack liquidity. All fund houses appoint market makers – brokers who create liquidity in ETFs. But they create liquidity only when there is demand.

ETFs also require demat account

As ETFs are traded on the stock exchanges, investors need a demat account to buy and sell them. “We found that a lot of retail investors got left out due to this demat account requirement,” says Niranjan Avasthi, Head-Product & Marketing at Edelweiss MF. He says that ETFs are mostly sold by brokers, but many distributors could not sell ETFs to their clients.

As per a recent Moneycontrol analysis, while ETF corpuses grew overall, retail investors preferred index funds over ETFs. Despite Nifty ETFs crossing Rs 1 trillion in August 2020, and the NSE listing its 100th ETF in July earlier this year, nearly 90 percent of ETF assets belong to the corporate investor, as per AMFI data.

Also read: Passive investing blazes a trail: Nifty ETFs cross Rs 1 trillion in assets

Those like Rushabh Desai, an AMFI-registered mutual fund distributor, prefer index funds to ETFs as well. “Sometimes, we have seen huge difference in ETFs’ market prices even within a day. It’s confusing for the retail investor why that happens. Unless an ETF offers an investment idea that is not available through any other means- a gold ETF for instance- we prefer index funds.”

Direct plan works better than ETFs

Many investors go by the advertised expense ratios of ETFs and take them to be the cheapest. In reality, an ETF doesn’t come as cheap.

Since ETFs are bought on the stock exchanges, you need to pay brokerage costs and GST. Besides, there is the impact cost, the difference between the net asset value and the market price at which you actually get to buy. Add demat charges, and the overall cost of holding an ETF can actually go up to as high as 42 basis points.

As per a recent Moneycontrol analysis, for index funds tracking the Nifty 50 index, the expense ratios of regular plans (as of February 2021) were 0.14-1.27 percent, while for direct plans, the figures were 0.05-0.91 percent. On the other hand, the expense ratios of ETFs tracking the Nifty 50 index were 0.05-0.16 percent. If you calculate the total cost of ownership for these ETFs, then it would increase to 0.47-0.58 percent.

To attract retail investors, many fund houses launch fund of funds to buy these ETFs. A FoF is a mutual fund scheme that invests its entire assets in the ETF. Such a scheme is a retail investor-friendly channel to invest in the ETF. Avasthi says that the FOF’s expense ratio rises a bit due its own expense ratio plus that of the underlying ETF. That is also why Edelweiss intends to launch mainly index funds in future. At least that is what is indicated, going by the offer documents it has filed with the capital market regulator SEBI.

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