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The Rise of ETFs Amidst Outflows in Mutual Funds

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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 outflows from almost all the categories, barring index funds and ETFs.

Data released by AMFI (Association of Mutual Funds in India), points out that not only the equity-oriented schemes but also the debt schemes witnessed a heavy net outflow in August 2020.

Net outflows from equity-oriented schemes stood at Rs 3,999.62 crore. Month-on-month the net outflows surged by 61% as July 2020 witnessed net outflows of Rs 2,480 crore.  The number is even greater if we compare the performance of August 2020 with August 2019 which saw net inflows of Rs 9,152 crore. Redemptions, too, were considerably higher as investors pulled out Rs 18,557 crores in August. Within equity funds, large-cap funds were worst hit, across all categories despite a relatively flat market in the month of August. Except for ELSS, focused funds, and thematic funds, all categories all registered outflows.

Equity Oriented Schemes
Source: AMFI, Tavaga Research

Surprisingly, income/debt oriented categories saw outflows as well. Data from AMFI suggests that July 2020 saw a net inflow of Rs 91,391 crore, while negative outflows of Rs 3,907 crore were seen in August 2020. Within the debt category, liquid funds and overnight funds were the worst hit as both the categories have consistently delivered lower returns for the last few months. Data suggests that investors continue to prefer the money market and low duration funds.

Debt Oriented Schemes

Source: AMFI, Tavaga Research

The net hybrid outflows decreased to Rs 4,819 crore in August from Rs 7,301 crore in July 2020 as redemptions were considerably lower month-on-month, while not much improvement was witnessed in the inflows.

Hybrid Schemes

Source: AMFI, Tavaga Research

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 232,505 crore in August from Rs 223,492 crore as the category witnessed a net inflow of Rs 2,865 crore. Gold ETFs, however, witnessed heavy redemptions in August as investors booked profits given the surge in gold prices.

ETF and Index Funds AUM

Source: AMFI, Tavaga Research

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 9% of the total AUM from 5.9% in August 2019.

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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!
Equity SIP Inflows

Source: AMFI, Tavaga Research

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, history will remember 2020 as the beginning of a turnaround in investor behavior as passive investments will only grow from here.

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