Should you opt for Index Fund or ETF?

By Ravi Samalad |  21-10-21 | 

In August 2021, Edelweiss Mutual Fund announced that it is converting two Exchange Traded Funds (ETFs) - Edelweiss Nifty 50 and Edelweiss 100 Quality 30 ETF into index funds.

The fund house took the decision to convert these ETFs into index funds as the schemes’ assets under management were quite low and hence could not provide enough liquidity to investors. Liquidity is one of the major requirements for an ETF, which allows investors to trade units seamlessly and reduces impact cost. As on July 30, 2021, the AUM of Edelweiss ETF Nifty 50 was Rs. 2.67 crore and the number of folios were 140.

While both schemes’ investment objective remains the same, this tweak into the structure of the fund is a change in fundamental attribute which requires the fund house to give an exit option to investors. The 30-day exit period of these schemes started on September 6, 2021 and ended on October 5, 2021.

Both the index funds will continue to track their underlying index, albeit in an index fund format. As the name suggests, Edelweiss ETF – Nifty 50 tracked the Nifty 50 Index.

Edelweiss 100 Quality ETF tracks the NIFTY100 Quality 30 index. This index includes top 30 companies from its parent NIFTY 100 index, selected based on their quality scores. The quality score for each company is determined based on return on equity (ROE), financial leverage (Debt/Equity Ratio) and earning (EPS) growth variability analysed during the previous five years.

Unlike ETFs, fund houses are not mandated by the regulator to list Index Funds on exchanges. However, fund houses at their sole discretion can list these schemes.

“We have filed our Large and Mid Cap, Financial Services Fund and launched Healthcare Fund on the index fund platform because it provides easy access to retail investors. So, these two funds (Nifty 50 ETF and Nifty 100 Quality 30 ETF) were quite old ETFs, and we thought converting them would be the prudent option, and most of our investors also gave the feedback that they needed index funds to set up SIPs in these funds. This change will enable investors to set up SIPs/STPs easily and access these strategies without needing a demat and broking account. With the change we expect a sizeable jump in the number of investors in these two index funds,” says Niranjan Avasthi, Head of Products, Marketing and Digital Business, Edelweiss Mutual Fund.

Let’s look at the pros and cons of ETF and index funds.

Bid Ask Spread: In an ETF, there could be a risk of investors not getting the desired price if liquidity is thin. When the trading is thin, the bid ask spreads tends to be wide. The spread is the difference between bid and ask price. Bid means buying price and ask is selling price. The bid reflects the demand for an ETF while ask reflects supply. A narrow bid ask spread is good, which reflects healthy trading volume. Investors don’t face this risk in an index funds because they are directly transacting with the fund house.

NAV: The main advantage of an ETF is that they are traded like stocks and investors get real time NAV. At times, units of ETFs may trade above or below their NAV. In contrast, index fund investors get the closing NAV which is declared by a fund at the end of day.

Demat Account: One major advantage which an index fund brings is that one does not need a demat account to invest in an Index Fund. Index Funds can be purchased through an AMC website, any aggregator or a distributor.

Options: Index Funds offer growth, dividend and dividend reinvestment options while ETFs don’t. 

SIP, SWP, STP: In Index Funds, one can do SIP of as little as Rs 500 per month. Such in built option is not available in an ETF structure. Lately, some brokerage firms have started providing SIP ETF option.  In an index fund, investors can also do Systematic Transfer Plan (STP) and Systematic Withdrawal Plan (SWP). SWP and STP options are not available in ETFs.

Cost: The expense ratio of ETFs tends to be less than index funds, but the difference is not huge. The TER of Edelweiss ETF – Nifty 100 Quality 30 was 0.243%. The index fund will charge 0.25 – 0.30% in direct plans and 0.95 - 1% in regular plan. The regulator has capped the TER of both Index Funds and ETF TERs at 1%. Edelweiss ETF Nifty 50 charged 0.070%.  Under Index Fund, it would charge 0.10 - 0.15% in direct plan and 0.45 – 0.50% in regular plan.

Further, Index Fund investors don’t have to incur brokerage cost and annual maintenance charges associated with a demat account.

Assets Under Management

While index funds are an easier option for retail investors, ETFs have gained considerable momentum which is evident by the number of folios. The industry has a total of 53 index funds with 16.22 lakh investor accounts or folios while there are 103 ETFs (excluding Gold ETFs) with 69.05 lakh folios as of September 2021.

The assets under management in index funds stands at Rs 31,906.83 crore as on September 2021. The AUM in ETFs (other than Gold ETFs) is much higher at Rs 3.56 lakh crore because Employee Provident Fund Organisation (EPFO) and large institutional investors prefer to invest via ETFs.

Which one should you choose?

The decision to invest in ETF versus an Index Fund would depend on your objective. Both have their pros and cons. Here are some factors which investors should keep in mind before choosing between an Index Fund or ETF.

READ: Index fund or ETF? 

Saurabh Mittal of Circle Wealth Advisors says that there is not a strong case to invest in ETFs for retail investors merely to save costs because of the inconvenience and challenges associated with ETFs at this juncture. “ETFs are usually preferred by institutional investors because they can directly transact with the AMC to minimise tracking error. The NAV of ETFs will have lower tracking error than the NAV of Index Funds because there is no cash component in ETFs.  For retail investors, it makes sense to go for Index Funds because there is not a huge difference between the TER of Index Fund and ETFs. Contrary to popular perception that ETFs are cheaper, one has to incur costs like brokerage, among others. There is also a tracking error. Investors also have to deal with intra-day volatility. It does not make sense to incur all this inconvenience without seemingly saving on some cost. If there is not a major difference in the TER of index fund and ETF, then it is better to choose Index Fund.”

Bengaluru-based RIA Basavaraj Tonagatti seconds Saurabh’s view. “Index funds would be better for retail investors. ETFs are not very liquid in India as compared to developed markets. One would constantly watch the performance of an ETF in demat account as they trade like stocks. So one may be tempted to sell if there is profit which defeats the purpose of long term investing. Also, it would be difficult to sell a Small Cap ETF in a falling market, especially when the liquidity is thin.”

Add a Comment
Please login or register to post a comment.
ninan joseph
Oct 24 2021 01:42 PM
 This is the problem with AMC in India. They never think of investors, all they think is about themselves. I fully understand the reason for closing down the ETF as it is better that way than having an illiquid ETF. However, for existing ETF holders who were moved to Index fund, is the commission the same. If they have done this then it is fine, if not, someone should question them.

ETF is a great product. In India, the best and most safe with regard to all these factors is going with SBI ETF.
Mutual Fund Tools
Ask Morningstar