Mumbai, July 20: IF innovation is the secret behind the success of any business, the mutual fund (MF) industry is almost there. With the stock market turning bullish at last, there could be no better time for the mutual funds to flood the market with innovative products.
Wary of fluctuations in the stock markets, fund managers have taken fancy to the new passively-managed like Exchange Traded Funds (ETF) and Funds of Funds (FoF).
ETF is basically a fund that tracks a particular index. After the initial open offer, these funds are listed and traded on the exchanges like any other stock. The advantage for small investors is that instead of buying a single stock of an index, they can buy the entire index stocks by investing in ETF.
FoF is the latest addition to the mutual funds kitty. Many mutual funds are planning to launch the scheme within the next three to six months. Many like HDFC MF, Prudential ICICI Asset Management Company and Tata MF are busy giving final touches to the FoF schemes.

ETFs are very popular in countries like the US where about 60 per cent of trading volume comes through ETFs alone. In the US, some 77 per cent of the active fund managers were off target and under-performed the S&P 500 Index consistently in the past 10 years. However, this may not be entirely true in the Indian context.



While backing such innovative products, market gurus are cautiously optimistic. ‘‘Though a theoretical case could be made for fund of funds, the general experience of this class of funds has not been positive. A major disadvantage is the added layer of costs that an investor has to bear. The second disadvantage is the limited and often questionable degree of value-addition,’’ said stock analyst Ramesh Pai.



On the positive side, ETF has many advantages for fund managers. ETF is expected to have a lower cost structure than an open-end index fund. Since the fund’s corpus does not change on a day-to-day basis, it requires less churning, saving the fund brokerage, commission and transaction costs. Also, new units in the fund are issued only in exchange for the underlying basket of shares, so the fund does not have to juggle its portfolio when it receives fresh inflows. The fund also does not have to maintain a significant cash component to service redemption demands. Levels of churning in the portfolio and a lower cash component also make for a lower tracking error in an ETF than an open-end index fund.



The first ETF to hit the market in India was the Nifty Benchmark Exchange Traded Scheme (NIFTY BeES), an open-ended ETF, which was listed on the NSE on January 8, 2002. Prudential ICICI AMC launched its ETF scheme ‘Spice’ early this year. Incidentally, ‘Spice’ was the country’s first Exchange Traded Fund on BSE-Sensex. Mutual fund behemoth Unit Trust of India stirred the market with its runaway success of ETF’s scheme Sunder. UTI has already pipped its ETF rivals hands down by garnering a whopping Rs 388 crore through the Sunder initial offer, while its nearest competitors Prudential ICICI’s SPICE has a corpus of Rs 22 crore and Nifty BeES has Rs 7 crore.



Nifty BeES is also considered equivalent to holding the Nifty 50 shares, allowing investors to take advantage of arbitrage opportunities between the cash and the index futures and options market. In the Indian context, this could provide liquidity to not only the cash market but also the derivatives segment. This is likely to appeal to small investors, who are averse to trading in index futures due to requirement of minimum contract size.



‘‘Usually, retail investors pick up stocks on the basis of some rumour or so-called ‘tips’ given by vested interests and ultimately are left to carr the baggage as the bigger operators book their profits at the right time. In the case of ETF there is no such headache. ETFs are also better than other open-ended index funds since they are open ended as well as listed. Hence, investors get an opportunity to capture intra-day movement in its price, which reflects the movements in the index,’’ said an investment advisor. ‘‘ETFs are safe returns and you can easily know the bottomline since it is not a single stock but an index,’’ he adds.



Market regulator Sebi is also examining the pros and cons of FoF investments and will be ready with the regulations early next fiscal. An FoF scheme is an MF scheme which invests in other MF schemes instead of investing in securities. Such schemes, which are prevalent in international markets, can have different investment patterns and investment strategies as disclosed in offer documents.



‘‘The fund manager of a particular AMC invests in other hedge funds rather than directly investing in securities such as stocks or money market instruments. These underlying hedge funds may follow a variety of investment strategies or may all employ similar approaches. Because investor capital is diversified among a number of different hedge fund managers, FoFs generally exhibit lower risk and is therefore an ideal method of diversification,’’ says a fund manager.



Innovations in investments always come with an element of risk. Hence only time can tell how far these funds will reward its retail investors.