What exactly are index ETFs?
An index ETF is just like an index fund. It creates a portfolio of index stocks like the Nifty or the Sensex. The portfolio of the index ETF mirrors the Nifty or the Sensex in terms of the stocks and also in terms of the proportion of each stock. Therefore buying into an index ETF is just like buying into the index at the current levels. But how is an index ETF different from an index fund?
Firstly, unlike an index fund that is open-ended, the index ETF is closed ended. That means, you don’t have the facility to purchase or redeem the ETF with the fund. Instead, these ETFs are listed and you can buy and sell them in the stock exchange. Secondly, index funds give you end-of-day NAVs whereas index ETF gives you live prices. ETFs are normally a fraction of 1/10th or 1/100th of the index value. If the Nifty or Sensex is volatile, as it was today, you can even buy fractional units of the index ETFs in the live market when the prices come down.
After a 27% correction, time is ripe for index ETFs
If you look at the history of corrections in the last 15 years, most of them have resulted in phenomenal returns in the next 2 to 3 years. Check the table below.
|Correction Phase||Percentage Correction||What happened Subsequently?|
|Jan-08 to Oct 08||-63.71%||By Nov 2010, Sensex had closed in on previous highs; a return of 180% in 2 years|
|May-06 to Jun-06||-30.56%||Index more than doubled in a little over 1 year by late 2007|
|Jan-04 to Aug-04||-19.64%||Index had touched a life-time high by June 2005 giving a return of more than 100%|
|Jul-11 to Dec-11||-20.89%||Returns were 45% in the next 1 year by the end of 2012|
We have only considered the post 2004 period as prior to that the derivatives market had not become active, and hence, may not be comparable. Without exception, in all the cases of a sharp correction of 20% or more, the markets have rebounded within a maximum of next 2 years. The best way to play the current situation is through the index ETF route.
ETFs bring low costs as a major advantage
If your question is, what the bottom of the market is, you must not worry about it. You can adopt a phased approach to investing in the index ETF over the next few weeks and you should get good rates. A market that has gone through such a sharp correction never exhibits a V-shaped recovery. It will be gradual and it will be volatile. That will give you lot of opportunities to accumulate the index ETFs at good prices.
The real big advantage is low costs. ETFs are passive investments on the index and you don’t worry about stock selection. Since our empirical data shows that indices have done well after such sharp corrections, there is a high probability of your generating solid returns in the next 2-3 years. The question is which ETFs to select and how to select?
Zeroing in on the index ETFs to invest in
Here are a few basic ideas to go about selecting index ETFs. Firstly, don’t go for thematic indices or sectoral indices. They may be too risky so best stick to the diversified indices like the Nifty and the Sensex. Secondly, look at the returns and the costs. Here is the table.
|Fund Name||YTD Returns (%)||Expense Ratio|
|Nippon India ETF Nifty||0.00%||0.97%|
|IDFC Sensex ETF||-8.08%||0.47%|
|LIC MF ETF Sensex ETF||-8.72%||0.10%|
|HDFC Nifty 50 ETF||-13.62%||0.05%|
|UTI Sensex ETF||-14.13%||0.20%|
The advantage in all the above ETFs is that you are catching the index after a 25% correction. Mostly, the expense ratios are extremely low and that can make a big difference to your returns over the next 2 to 3 years. It is time to take out your cheque book and fill out the form to invest in an index ETF.