Let's settle the issue of ETF's and liquidity once and for all - Here's my analysis of six Indian ETFs and thier trading volumes

[onisim]

I've heard many arguments here about ETF's and liquidity etc. I think they are genuine concerns and needs to be looked into with a little more depth.

I've taken six ETF's here - one's that I have currently invested in. I prefer ETF's to mutual funds as I get to track their history in a Google Sheet and current values compared to Mutual Funds.

Also, with lower Expense Ratios, I find that ETF's are cheaper than equivalent Mutual Funds (even if you include AMC). I will consider Zerodha here (~Rs. 400 AMC).

The six funds I am considering here are:

NIFTYBEES - Best liquidity - Heavy trading volumes. This ETF has been active since 2002(I was a kid back then) and there is excellent history on this.

https://imgur.com/VeC1tUi

JUNIORBEES - Lower than NIFTYBEES but adequate

https://imgur.com/PdrCUvK

UTINIFTETF - Lowish volumes - Difficult to sell large blocks of shares.

https://imgur.com/XmInjlU

Average volume in 2020 is 14,653 shares per day * Current Price (Rs. 990) = Rs. 1,45,06,470. If you wanted to sell 1cr. worth of shares it would be difficult. But, for a buy and hold investor, I would sell may be 100-1000 shares a day. No problem for this ETF.

UTINEXT50 - Average volume in 2020 is 89,000 shares * Rs. 245 per share = Rs. 2,18,05,000. Again, selling chunks would not be a huge deal.

https://imgur.com/C2tqup8

NETFLTGILT - Average volume in 2020 is 4,20,7835 shares * Rs 21 per share = 8,83,64,535.

https://imgur.com/Sam6XFo

ICICI500 - Average volume in 2020 is 32,92,468 shares * Rs. 123 per share = Rs. 40,49,73,564. https://imgur.com/Rti1BbK

ETF Volumes over time - All normalized to 500,000 shares.

I'm not a rich guy, but these are large chunks of money to me. If you are a buy and hold investor, I don't see why investing in ETF's are an issue.

When it comes to expense ratios, I find that ETF's are cheaper than their equivalent mutual funds.

Here is the proof. This includes only equity ETF's. Total Expense Ratio (MF vs ETF)

I used Google Sheets to pull all this data from GOOGLEFINANCE.

So, can someone explain to me why they think ETF's have low liquidity? Why ETF's cost more than Mutual Funds?

PS: I am not going to go to Creation Units and how market makers "add" liquidity when there is extreme redemption pressure etc. But, here is a link to Vanguard's explanation.

 

[nischansr]

@onisim Thanks for this.

Liquidity is one aspect, but tracking accuracy is another. If you could, can you track price as well?

Because just the other day I was looking into the SBI nifty next 50 etf for some reason and the price was often way off compared to the underlying index particularly in the volatile last few weeks. At that point, I didn't even bother to check liquidity. My check was made on zerodha. I'd assume the charts there indicate closing prices.

While I don't have anything to hate wrt ETFs, I don't get their utility in India. Sure they let you trade during market hours, but besides that what exactly does one gain? How different are the expenses?

For example - to the best of my understanding - they make sense in the US by the manner in which they can execute heartbeat trades to essentially nullify internal capital gains (which they are actually taxed on, apparently), while simultaneously, the mutual funds are forced to disburse the gains (no growth funds) and the difference apparently adds up - particularly in the cases of funds that track indices which are more dynamic in their constitution compared to something like the S&P500. I don't understand it really well, but that seems to the gist of it - that ETFs are actually more tax efficient for the individual investors even when tracking the same index.

But that isn't the case in India. Growth mutual funds exist, and these mutual funds don't pay taxes when reshuffling their portfolio. So why exactly even bother with ETFs?

 

[annacola]

@nischansr

While I don't have anything to hate wrt ETFs, I don't get their utility in India. Sure they let you trade during market hours, but besides that what exactly does one gain? How different are the expenses?

It allows for more nimble rebalancing since one doesn't have to wait three working days for payout plus another day for knowing the actual NAV.

All the time hoping market hasn't moved significantly.

 

[nischansr]

@annacola You can avoid this problem even for mutual funds - buy and sell on the same day so that the same day's nav is applied to both transactions (even if they are different funds). True this limits you to 2L transactions, but that isn't such a big limitation afterall unless you have really large corpus, and therefore the rebalancing involves large sums. Even then, one can spread it over n days, but yeah some may not like it.

 

[annacola]

@nischansr This isn't fool proof. Most of the time the funds are deducted from ones account on the same day while placing the buy order, so one needs to have spare cash lying around.

 

[nischansr]

@annacola Well, 2L in spare cash in the bank acc for someone trying to rebalance atleast 2L (and thus having a large-ish portfolio) isn't such a major ask. And in 3 odd days that 2L will be replenished anyways.

 

[annacola]

@nischansr You're constantly shifting goalposts so I'm a bit lost. Can you elaborate a bit on your method?

Say I have 1L which I need to move from equity to debt MFs or vice versa. Assume I don't have spare 1L lying around in my bank account just for rebalancing (That would be suboptimal).

What exact steps (and in what order) should I make so that the problem is avoided?

 

[nischansr]

@annacola What shifting goalposts?

I assume that if your portfolio is so large that the you need a 2L or larger rebalancing, then it's not too hard to imagine having a 2L amount in the bank account (or one of those flexi deposits). That'd be your emergency fund, if nothing else.

Then you initiate the sell and buy transactions on whatever funds you want on the same day before the cut off time. This way you get the same day's nav's on both funds. And 2L will be debited from your account today (for the purchase side) and 2L would be credited back to it in about 3 days or so (from the sale side). Not that complicated.

 

[onisim]

@nischansr I have not tracked price but, I look at '1 Year', '3 Year' and 'Since Inception' comparisons of these funds and they are pretty much equal to their indexes (+-0.2%), which is good enough for me.

Tracking errors can increase during volatile periods but as a passive investor it shouldn't matter as over time it will stabilize.

Just as an example, Berkshire Class A and Class B shares are supposed to be 1:1500 ratio as that's how W.B created them. But, look at this graph to see how wildly they can vary.

These are the values if you don't want to look at the graph.

MIN 1471

MEAN 1504

MEDIAN 1501

MAX 1613

You can see that during times of high volatility, it does deviate but comes back down during normal times.

Well, in my case I hate paying exorbitant expense ratios for sleepy boring index funds. There is a huge difference in expense ratios between fund houses offering the same index with the same underlying index. I can get these index funds for cheaper with an ETF, even if you include AMC charges (see my table in the original post). A difference of Rs. 2,500 per year can add up. Tracking error differences are much lesser than that.

 

[ranran19]

@onisim

I look at '1 Year', '3 Year' and 'Since Inception' comparisons of these funds and they are pretty much equal to their indexes

There is end-point bias in such comparisons. That is the point behind doing actual analysis.

There is a huge difference in expense ratios between fund houses offering the same index with the same underlying index.

Again, that's the factor r/additional_trouble seems to be calling out. Just replace the word "expense ratio" with "liquidity" and look at this statement for ETFs (which too are offered by fund houses only) -

There is a huge difference in liquidity between fund houses offering the same index with the same underlying index. (for ETFs)

If you can choose the one that's most liquid (say UTINEXT50), you can also choose the index fund that has the least expense ratio!

 

[nischansr]

@ranran19 And let me add that the volatility (just the difference between the ETF price and the NAV, not talking about the volatility of the underlying index itself which is common between both mutual funds and ETFs.) makes it possible for entry points to differ significantly from the actual index value - such that it plays into the returns and eats away (or enhances) the additional returns from a reduced expense ratio.

Even more - aren't ETFs dividend distributing (someone correct me if I am wrong)? Again, with dividends becoming taxable it's making the ETF again less efficient than a comparable growth mutual fund.

A 0.05% difference in expense ratios (ie the ETF is cheaper) is just Rs. 50 per lakh per year. A 1cr portfolio is still only paying 5k extra. At a 0.2% difference in expense ratios it's 20k saved. And as an example the UTI nifty50 MF runs at something like 0.1% expense ratio. And iirc, even the nifty next 50 is under 0.3%

And that's before the dividend - assume 1.5% - of 1.5L and the difference in taxation for someone in the 30% bracket is: 30% of 1.5L = 50k tax on the dividend from the etf, vs an eventual 10% of 1.5L = 15k for the growth fund. A downside of about 35k for the etf holder. Yes its a specific case (and that too only approximately) in a specific income tax bracket, but...

I still don't see a convincing universal case for ETFs against growth mutual funds in India...

 

[ranran19]

@nischansr

aren't ETFs dividend distributing (someone correct me if I am wrong)? Again, with dividends becoming taxable it's making the ETF again less efficient than a comparable growth mutual fund

Very good point indeed. Yes, ETFs pay out dividends which are taxable. This in itself is a strong factor against ETF (at least for those holding a large corpus.)

 

[ranran19]

I stand corrected. 1) Not all ETFs in India pay dividends. Most don't. 2) Those that do, do so very irregularly and have been reducing the payout frequency of late. (example.) I expect this behaviour to continue in the current tax regime.

 

[nischansr]

@ranran19

1) Not all ETFs in India pay dividends

Can you provide me a link?

Didnt find anything useful when I checked and its a pain to search on the phone.

 

[ranran19]

@nischansr I just checked dividend history for several ETFs on their individual pages.

 

[onisim]

@nischansr Sorry, I can't find any link either. But, I think the government changed the rules for dividends some time back. So, these ETF's stopped paying dividends.

 

[nischansr]

@onisim @denorasweet, @zashmaster, @crixus123, @gunderson500 - anyone knows what's the deal with Indian index etfs and dividends? I can't seem to find any concrete evidence either way.

It looks like many just stopped paying dividends. But nothing suggests that the dividends are being reinvested - except that their tracking errors have remained low... So are they actually now growth ETFs that silently reinvest dividends without disbursement?

 

[onisim]

@nischansr ETF volatility is a genuine concern, but you are making the assumption that you're dropping a large lumpsum amount during high volatility days. If you don't do anything during high volatility days and have some kind of SIP (manual), I don't think that it matters again. The best thing to do when you notice a large departure between price and NAV is not do anything. Things will settle down and you can buy then.

On the contrary, ETF's do not distribute any dividends. I have not received any dividends since three years from any of the ETF's I listed.

That is true. Over time, both expense ratios have reduced. If I remember correctly, when I was looking at ETF funds that tracked Nifty Next 50, lowest expense ratio for an ETF was 0.15% and mutual fund was 0.27% or 0.3%. This adds up if you're holding for a long time.

My point was to not make a universal case for ETF's. I wanted to rest the case that "ETF's don't have liquidity" especially when delivery charges is Rs. 0 from Zerodha.

 

[nischansr]

@onisim

My point was to not make a universal case for ETF's. I wanted to rest the case that "ETF's don't have liquidity" especially when delivery charges is Rs. 0 from Zerodha.

Point taken

Edit: btw, not sure whats going on, but the few nifty ETFs I checked all have a history of giving out dividends, though not regularly.

 

[thoughtlessdepth]

@onisim

On the contrary, ETF's do not distribute any dividends. I have not received any dividends since three years from any of the ETF's I listed.

I got dividend from NIFTYBEES back when goldman sachs owned it.