ETFs to make a bow

Suresh Krishnamurthy

EXCHANGE traded funds, which have a major market presence abroad, could shortly enter the Indian mutual fund market.

The Unit Trust of India, in association with the Bombay Stock Exchange, is likely to introduce exchange traded index funds.

Exchange traded funds are a variation of close-ended funds. These funds would be traded in the stock market. However, quite unlike close-ended funds, investors, by surrendering their units to the mutual fund, would be able to get the securities underlying the units. For example, suppose a mutual fund had invested in five stocks in varying proportions. If an investor then surrenders units, he would get these five stocks in the same proportion. The value of securities issued would be equivalent to the value of units surrendered.

Such an innovation helps address a major problem associated with close-ended funds. It reduces the discount at which close-ended funds are traded in the secondary market. At the same time, it also offers the same high degree of freedom to fund managers that close-ended funds provide.

In the Indian market, exchange traded funds have one major drawback. They are applicable only to large investors. Consider a fund that has invested 10 per cent in Infosys Technologies. In such a case, the minimum value of units that an investor should surrender would be of the order of Rs 70,000. For a retail investor, this is certainly a tall order.

A similar situation is likely to obtain in the case of index funds where Infosys Technologies has a weightage of around 15 per cent. And there is the danger that the discount at which funds are traded would continue to rule high if retail participation in a scheme is high. It does appear that greater innovation is necessary to ensure the participation of retail investors in ETFs.