ETFs Vs Mutual Funds

Low-cost passive investment products like ETFs and Index Funds are set to challenge large-cap mutual fund schemes, says Malini Bhupta

- Malini Bhupta

Imagine walking into a retail store and seeing two similar products priced differently. Which one would you choose? Obviously, the one that is priced less, if all other things remain the same. It is time then that investors view financial products in the same light as they do other products because the charges you pay to manufacturers erode returns. This is more relevant for investments made in large-cap equity mutual funds because their expense ratios are anywhere between 2.5-3.5 per cent.

So, if investors are looking at participating in equity markets at significantly lower costs, then passive investment options like exchange traded funds (ETFs) make for a compelling option. ETFs are similar to mutual funds, but they follow benchmark indices like the Nifty or Sensex. On the other hand, mutual funds are actively managed by fund managers. Among other reasons, actively managed funds charge higher management fee because such funds can generate higher returns than the benchmarks. But even globally, it is widely accepted that beating the benchmarks is becoming tough. So if a fund manager cannot beat the benchmark and continues to charge higher expenses, then returns will be comparatively lower.

Interestingly, in developed markets like the US, such passive funds have consistently done better than actively managed funds. Says Ashishkumar Chauhan, MD and CEO, BSE: “Internationally, ETFs have taken over the world such that they are bigger than all funds. An ETF investor knows exactly where the money is invested and that too at lower costs. In an ETF, the cost of distribution goes away as funds are traded on the exchange.”