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The Rise of ETFs

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The Rise of ETFs and Index Funds Amidst Outflows in Mutual Funds

By: Tavaga Research

The Indian mutual fund industry witnessed yet another month of net inflows from almost all the categories, barring income/debt oriented category.

Data released by AMFI (Association of Mutual Funds in India), points out that equity-oriented schemes witnessed a heavy net inflow in December 2021.

Net inflows from equity-oriented schemes stood at Rs 25082.54 crore. Month-on-month the net inflows increased as November 2021 witnessed net inflows of Rs 11614.73 crore. December 2020 saw net outflows of Rs 10,147.12 crore. Redemptions were considerably higher as investors pulled out Rs 17722.45 crores in December 2021. Within equity funds, dividend yield funds saw minimum inflow, across all categories despite a rising market in the month of December. All categories have registered net inflows in December 2021.

Source: AMFI

The income/debt oriented categories witnessed heavy outflows. Data from AMFI suggests that November 2021 saw a net inflow of Rs 14,893.08 crore and December 2021 saw a net outflow of Rs. 49,037.52. Within this category, Low duration funds and liquid funds saw majority outflows, while investors put in money in Overnight Fund and Dynamic Bond fund.

Source: AMFI, Tavaga Research

The net hybrid inflows reduced to Rs 563.40 crore in December 2021 from Rs 9,422.04 crore in November 2021 as redemptions were considerably higher month-on-month, with Rs. 17326.09 crore in December 2021 vs Rs. 12501.41 Crore in November 2021.

Source: AMFI

ETFs and Index Funds Emerge as the Clear Winners

Investors continue to pour money into passive instruments such as ETFs, including gold ETFs and index funds on the backdrop of low and negative returns in actively managed mutual funds. The assets under management of ETFs and index funds rose to Rs 4,72,179.19 crore in December 2021 from Rs 4,47,278.45 crore in November 2021 as the category witnessed a net inflow of Rs 18,705.71 crore.

Source: AMFI

The change of attitude by retail investors as they continue to invest heavily in passive instruments despite challenging economic scenarios is worth appreciating. Passive instruments are rapidly gaining traction not only amongst High Net-Worth Individuals (HNIs) but also amongst retail investors. This is evident with the fact that AUM of ETFs and index funds rose to 12.7% of the total AUM in December 2021 from 9.21% in December 2020.

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Are ETFs and Index Mutual Funds the same?

While both the categories invest the money mobilized from investors in a pre-decided benchmark, the primary difference between these two instruments is, index funds are not traded on any stock exchange, however, Exchange-Traded Funds (ETFs) trade on a stock exchange, like any other security.

Below are the differences between ETFs and Index Funds:

Differences between ETFs and Index Funds
Source: Tavaga Research

Why are active mutual funds witnessing outflows and why this trend might continue?

  • Since the beginning of the pandemic caused due to Covid-19, many people have lost their jobs, incomes have fallen, and many small businesses have shut down. As a result, the affected category of retail investors have temporarily stopped their SIPs
  • Retail investors have taken the stock market route and they now prefer buying ETFs and invest money in stocks, directly, rather than purchasing active mutual fund units
  • Many investors have fallen prey to the Franklin Templeton Mutual Fund fiasco and have either stopped or reduced investing in debt schemes as the fixed income category hasn’t lived true to its label!
Source: AMFI Data

What future lies in for Passive Investments?

Investing in index funds and ETFs has been the most convenient way to own top stocks. Benefits such as transparency, diversification, low-costs make this category more attractive amongst investors.  While in India, the AUM of passive instruments is less than 10%, developed markets like the US have it over 50%. Moreover, the investor does not have any control over an active fund manager’s investment strategy and is bound to fall prey to the behavioral biases. Also, the outperformance of most indices over active funds has made this category more attractive to investors.

From the data presented above, its the beginning of a turnaround in investor behaviour as passive investments will only grow from here.

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