With so many types of mutual funds, we are truly spoilt for choices when choosing the perfect one. Exchange-Traded Funds (ETFs) are a relatively new entrant in the mutual funds market, being barely 20 years old in India. ETFs are consolidating their position in the Indian mutual fund scene despite their tender age with its low cost and near-perfect mirroring of the underlying index. Given their early promise, the obvious question begging to be asked is, what the future holds for ETFs?
If we try to look into the crystal ball to predict future market behaviour, the market has this bad habit of throwing the ball right back at us. Nevertheless, we can look at trends and get an idea of the future of ETF in India.
Closer to the Index
ETFs are mostly passively managed funds. There is minimal fund manager intervention as the fund simply tries to follow the movement of the underlying index or indices. This reduces the maintenance cost of the fund. But more than the cost, you are almost certain to get a similar return to what the index is generating as a whole. On the other hand, actively managed funds tinker with their portfolio and aim to beat the market growth.
89% of actively managed large-cap funds failed to beat the benchmark indices in the US, as did 93% of small and mid-caps. Experts have observed that in the long run, actively managed funds dip. Consequently, these actively managed funds almost certainly lost out to most ETF funds as well.
In the US, the AUM of passive funds exceeded that of actively managed funds for the first time in history in September 2019. In India, funds managed by index-based funds increased to 51% in 2019, from 5% in 1995.
It proves ETFs with smart benchmarking have a strong future in the market.
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