Consistent performance, low tracking error

Passively-managed products are catching up with Indian investors in a big way. Exchange traded funds (ETFs) are passively managed funds which invest into an underlying asset or portfolio of assets and trade over stock exchanges. The underlying portfolio may represent an index, securities or commodities.

Equity ETFs invest in a basket of stocks in the same proportion, as the ETF’s benchmark index.

ETFs can be easily bought/sold anytime during the market hours like any other stock on the exchange through terminals. The trading price is usually close to the actual NAV (net asset value) of the fund. Investors who seek market exposure through mutual funds, but are uncertain of which fund to buy, can use equity ETFs to their advantage. According to the latest edition of S&P Crisil Spiva (Standard & Poor’s Index Versus Active Funds) scorecard, a majority of largecap funds have underperformed the S&P CNX Nifty Index across one, three and five year time frames. Over the last one year period, 77 per cent of the largecap oriented equity funds have given returns lower than the index.

Apart from tradability, other advantages of ETFs include diversification, exposure to the index constituents through a single unit, low expense ratios, no exit load and elimination of fund manager’s bias. Investments in ETFs, however, require investors to hold share trading and demat accounts.

NIFTY BENCHMARK ETF
Nifty Benchmark Exchange Traded Fund (Nifty BeES) was launched in December 2001 by the Benchmark Mutual Fund and was India’s first ETF. The fund house on Thursday is the largest ETF manager in India focusing on index based products. The fund is managed by Vishal Jain since its inception.

Nifty BeES tracks the S&P CNX Nifty Index and is listed on the NSE. The investment objective of the Nifty BeES is to provide returns, which before expenses, closely correspond to the total returns of securities represented by the S&P CNX Nifty Index.

The fund had average assets-under-management of Rs 622 crore as of the month ended February. According to the Crisil mutual fund ranking for index funds, Nifty BeES has been consistently fund rank 1 – in the top 10 percentile – for the past 16 quarters. The category ranks funds which track the S&P CNX Nifty or BSE Sensex index.

Investors seeking exposure to all the 50 stocks of a largecap index viz. S&P CNX Nifty can invest in the fund. One unit of the Nifty BeES represents approximately 1/10th of the S&P CNX Nifty Index. Its expense ratio is 0.5 per cent vis-à-vis 1-1.5 per cent in the case of index funds. Investors should note that there could be additional brokerage and transaction charges for ETFs.

TRACKING ERROR
Till March 24, Nifty BeES delivered a compounded annualised growth rate (CAGR), of 21.52 per cent vis-à-vis 21.28 per cent by the S&P CNX Nifty total returns index (TRI). TRI measures the value of the index assuming that all dividends distributed were reinvested. The basic difference between two passively managed ETFs is in the funds’ tracking error. Tracking Error is an estimate of how closely the returns of the fund correspond to the returns of its benchmark’s TRI. Lower the tracking error, the closer are the returns of the fund to the benchmark index. Within the Index funds category of Crisil mutual fund rankings, Nifty BeES has the lowest tracking error. The fund has an annualised tracking error of 0.09 per cent over the last one year, as of February 2011. The range of tracking error varies from 0.12 to 3.23 across other index funds.

IMPACT COST
Impact cost is a key parameter that investors should look at before they invest in an ETF. Since ETFs are redeemed by the mutual fund only in predefined lot sizes, trading of units on the exchange is the primary source of liquidity of units. The impact cost is a measure of the volumes traded on the exchange and represents the liquidity for the ETF. Impact cost is also known as bid-ask spread. The impact cost of the Nifty BeES is 0.11 as of February (Source: NSE).

PORTFOLIO ANALYSIS
The Nifty BeES tracks the S&P CNX Nifty, a diversified index representing the top 50 stocks by market capitalisation listed on the exchange and 23 sectors of the Indian economy. Since this is a passively managed fund, the fund manager does not take any active calls in terms of portfolio constituents and their weights.

The top three sectors in the fund’s portfolio are banks, petroleum products and software which together account for 39 per cent of the portfolio over the last three years. The top three stocks in the portfolio over the last three years are Reliance Industries, Infosys and ICICI Bank which together constitute 23 per cent on an average over the past three years.

Source: http://www.business-standard.com/india/news/consistent-performance-low-tracking-error/430512/