PROJECT ON

COMPARATIVE STUDY ON INDEX FUNDS AND EXCHANGE

TRADED FUNDS (ETFS)

1
 PROJECT ON

COMPARATIVE STUDY ON INDEX FUNDS AND EXCHANGE

TRADED FUNDS (ETFS)

2
 M.L.Dahanukar College of Commerce

Vile Parle (E), Mumbai-400057

CERTIFICATE

This is to certify that Mr. Harshad Anant Sangar has worked and duly completed her project
work for the degree of Bachelor in Commerce (Financial Markets) under the Faculty of
Commerce in the subject of Detailed study of Index Funds vis a vis Exchange traded Funds
and his project is entitled,”Comparison of Index Funds and Exchange Traded Funds (ETFs)”
under my supervision.

I further certify that the entire work has been done by the learner under my guidance and that
no part of it has been submitted previously for any Degree or Diploma of any University.

It is his own work and facts reported by her personal findings and investigations.

Name and signature of

Guiding Teacher

Prof. Rugved Shivgan

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Date of submission

Acknowledgment

The list who helped me is difficult because they are so numerous and the depth is so
enormous.

I would like to acknowledge the following as being idealistic channels and fresh dimensions
in the completion of this project.

I take this opportunity to thank the University of Mumbai for giving me chance to do this
project.

I would like to thank my Principal, Dr. Dnyaneshwar. M. Doke for providing the necessary
facilities required for completion of this project.

I would also like to express my sincere gratitude towards my project guide Prof. Rugved
Shivgan whose guidance and care made the project successful.

I would like to thank my College Library, for having provided various references books and
magazines related to my project.

Lastly, I would like to thank each and every person who directly or indirectly helped me in
the completion of the project especially my parents and peers who supported me throughout
my project.

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 Declaration by learner

I the undersigned Mr. Harshad Anant Sangar here by, declare that the work embodied in this
project work titled “Comparison of Index Funds and Exchange Traded Funds (ETFs)” from
my own contribution to the research work carried out under the guidance Prof. Rugved
Shivgan is a result of my own research work and has not been previously submitted to any
other University for any other degree/ Diploma to this or any other University.

Wherever references has been made to previous works of others, it has been clearly indicated
as such and included in the bibliography.

I, here by further declare that all information of this document has been obtained and
presented in accordance with academic rules and ethical conduct.

Name and Signature of the learner

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 INDEX
Page
Sr No. Particulars No.
1 Introduction
1.1 An Overview of Index Funds
1.1.1 Types of Index Funds
1.1.2 The Advantages of Index Funds
1.1.3 Characteristics of Index Funds
1.1.4 Need for index Fund
1.1.5 The Rationale of Index Fund
1.1.6 The Mechanics of Index Fund
1.1.7 Structure of Index Fund in India
1.1.8 Disadvantages of index Fund
1.1.9 Choice and Construction of Index
1.1.10 Method of implementing of Index Funds
1.1.10.
1 Sensex- The Barometer of Indian Capital Markets
1.1.10.
2 Timing Of Changes
1.1.10.
3 Additions
1.1.10.
4 Deletions
1.1.10.
5 Rebalancing
Popular Indices on which Index Funds are built in
1.1.11 India
1.2 Exchange Traded Funds(ETFs)
1.2.1 History and Development of ETFs
1.2.2 Types of ETF
1.2.3 Indian Scenario
1.2.3.1 ETFs and India
1.2.3.2 Types of ETFs in India
1.2.4 ETF Trading Mechanism
1.2.5 Significance of Asset Allocation
1.2.6 Using ETFs to diversify your portfolio
1.2.7 ETF and Investor Suitability

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1.2.8 Positive Attributes of EtFs
1.2.9 Limitations of ETF
2 Research Methodology
2.1 Introduction
2.2 Objectives
2.3 Research Methodology
2.4 Importance of Study
2.5 Limitation of Study
3 Review of Literature
4 Analysis and Interpretation
5 Conclusion

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 CHAPTER I

1. INTRODUCTION:-

Although Index mutual funds and Exchange traded funds looks similar but they in real term
they differ in various aspect. Index mutual funds have been around for quite some time but
the popularity of Exchange Traded Funds (ETFs) among retail investors is rising. ETFs and
index funds are simply 2 different ways of investing in a similar portfolio of shares. Both
have their own advantages and disadvantages.

The passive investment management philosophy began in 1971 at Wells Fargo

with simple index funds. Growth of index funds in United States was dramatic in the
1970s and 1980s and gained impetus in the UK and Europe in the 1980s. In India, the
first index fund was launched by the Unit Trust of India in 1998. This segment is
expected to grow. In particular, this product seems to appeal to the institutional
investors and the corporations.

Indexing has flourished because it is compatible with both theoretical findings

and practical needs. On the theoretical side, the philosophy of passive fund
management emanates from the efficient market hypothesis. If the markets are
difficult to beat, then there is no point in spending money to devise methods and
strategies to outperform the market. Instead of the “high return high cost” approach it
is better to focus on “market return low cost” approach. This kind of differentiated
product has an appeal to treasury managers and high net worth individuals and has
resulted in huge inflows from institutions, corporations and high net worth individuals.
These investors are in a position to demand and expect pre-defined performance from
the investment managers. They not only look at the overall performance but also
investigate the factors that contribute to the overall performance. The fund

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management company has to respond to this situation. Therefore, it is of paramount
significance that we find a method to attribute the overall Index fund performance to
causal factors of relevance.

In the decade of the 1960s and 1970s, many studies indicated that actively
managed funds which seek to obtain excess returns by actively forecasting returns on
individual stocks, do not actually obtain statistically significant excess returns. This
was consistent with the hypothesis of ‘market efficiency’, which suggested that
obtaining excess returns should be difficult in a competitive market. These researches
suggested a superior investment strategy: the index fund. This would be a portfolio
which passively replicated the returns of the index. The most useful kind of market
index is one where the weight attached to a stock is proportional to its market
capitalization

1.1 AN OVERVIEW OF INDEX FUND

It was 1976 when John Bogle introduced the world’s first index mutual fund into
the marketplace. The idea for the fund, the First Index Investment Trust, was simple:
create a basic, low-cost portfolio that mirrors the performance of the Standard &
Poor’s 500 stock index. An index fund (also index tracker) is an investment fund
(usually a mutual fund or exchange-traded fund) that aims to replicate the movements
of an index of a specific financial market.

An Index fund follows a passive investing strategy called indexing. It usually

holds stock in the same proportion as that in the represented index. It doesn't aim to
outperform the index but tries to imitate the performance of the benchmarked index.
This strategy is not concerned with asset selection or stock picking but only to
minimize cost. Passive or index Funds is a category of funds which is been invested
into only those securities which are been in any indices namely, Sensex, Nifty,
HangSeng, Russell 2000. Its daily returns are the same as the daily returns obtained
from an index. A Nifty index fund has all its money invested in the Nifty fifty
companies, held in the same weights of the companies which are held in the index.
This type of fund management leaves no decisions open, about what companies to

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hold and how much to invest in each company. The objective of index funds is to
track the ideal market index or their ideal portfolio. Many of the index funds also
invest in derivatives such as futures and options. Some Index funds are invested in
indices companies as same ratio as they were included in indices while some index
funds only invest in all companies as sample.

1.1.1.TYPES OF INDEX FUNDS

 Traditional open ended Index Mutual Fund

 Exchange Traded Funds or ETFs

An Exchange Traded Fund (ETF) is an open-ended mutual fund scheme which

is listed and traded on the stock exchange like a stock. Primarily, ETFs are passively
managed and their objective is to capture the behavior of the underlying i.e. equities,
fixed income or commodities. An Exchange-Traded Fund (ETF) is a security that
tracks an index, a commodity or invests in money market instruments. Equity ETFs
allow exposure to entire markets, yet have characteristics of a stock as they are listed
on a stock exchange and can be bought and sold daily.

1.1.2. THE ADVANTAGES OF INDEX FUNDS

In comparison to actively managed funds, Index funds have the following
advantages:

 Low Risk
Index funds track a broad index, which is less volatile than specific stocks or
sectors, thereby lessening the risk for investors.

 Low Costs
Because the composition of a target index is a known quantity, it costs less to
run an index fund. No highly paid stock pickers or analysts are needed. Lower
transaction costs and fewer expenses make index funds cheaper than the actively
managed funds. Generally the expense ratio of index funds ranges from 0.5% to 1.5%

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compared with up to 2.5% in diversified funds.

 Simplicity
The investment objectives of index funds are easy to understand. Once an
investor knows the target index of an index fund, what securities the index fund will
hold can be determined directly.

 No change in investment style

Style drift occurs when actively managed mutual funds go outside of their
described style (i.e. mid-cap value, large cap income, etc) to increase returns. Such
drift hurts portfolios that are built with diversifications as a high priority.

 Lower turnovers
Turnover refers to the selling and buying of securities by the fund manager.
Because index funds are passive investments, the turnovers are lower than actively
managed funds resulting in low cost of maintenance.

 Diversification
Diversification refers to the number of different securities in a fund. A fund with
more securities is said to be better diversified than a fund with smaller number of
securities. Owning many securities reduces volatility by decreasing the impact of
large price swings above or below the average return in a single security.

 Well Researched Portfolio

Sensex has 30 large cap stocks representing 12 Sectors. There are stiff criteria for
stocks to remain part of the Sensex. An expert committee reviews these stocks on a
quarterly basis based on listed history, market capitalization weightage, trading
frequency, industry and sector representation, track record and if they fail to meet the
criteria laid down they are replaced by another stock which fulfills the criteria.

 Passive management (also called passive investing) is a financial strategy in

which an investor (or a fund manager) invests in accordance with a pre-determined

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strategy that doesn't entail any forecasting . Bytracking an index, an investment portfolio
typically gets good diversification, lowturnover, and extremely lowmanagement fees.
Passive management is most common on the equity market, where index funds
track a stock market index. One of the largest equity mutual funds, the Vanguard 500,
is a passive management fund.

1.1.3.CHARACTERISTICS OF AN INDEX FUND

 Make no attempt at forecasts and analysis as its objective is to closely replicate the
performance of the target Index. Thus the performance of index scheme would
rise or fall in accordance with the rise or fall in the target index.
 Reduce non-systemic risk, i.e. risk that is unique to an individual company or
industry is minimized.
 Lower expense ratios.
 Ease in portfolio construction, monitoring and rebalancing.
 Allocate across asset classes which are not correlated, e.g. portfolio comprised of
GS Nifty BeES, GS Junior BeES, GS Liquid BeES and GS Gold BeES.

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1.1.4. NEED FOR INDEX FUNDS
Here are certain compelling reasons to invest in equities through Index Funds.

 Diversified portfolio at all times:

As the most effective de-risking strategy, diversification involves spreading a
portfolio across various sectors and companies. The idea is that even if a particular
company in the portfolio fails to deliver, some others compensate for it. Fund
managers will always articulate the merits of diversification, but they are still prone to
chasing fads and trends, in the process giving the short shrift to diversification.
An Index Fund that mirrors the Nifty will invest only in the 50 Nifty
stocks - that too in the same proportion as their weightage in the Index at all times.

 Assured play on emerging sector stories:

The stocks that make up these premier indices are chosen after a stringent
screening process. Broadly speaking, a stock must show two attributes to be
considered for inclusion in an Index: it should be a worthy representation of a
prominent or growing sector and it must see active trading interest. This ensures that
the Index – and therefore, the Index Fund – is made up of quality stocks that together
reflect the state of economic activity in the country.

 No fund manager risk:

Portfolio changes in Index Funds automatically reflect changes in the Index
they track. They are not subject to a fund manager’s investment preferences, or his
whims and fancies. In an actively managed equity fund, a fund manager can make or
break the fund with his choice of stocks, and timing of entry and exit. The passive
nature of Index Funds neutralizes this fund manager risk.

 Liquid portfolio holdings:

The equity portfolio of US-64 contains 81 delisted companies, the investment
cost of which is Rs 127 crore! Many other funds hold stocks that are illiquid or
unlisted on the bourses, which have a regressive impact on one’s investment. Exit
options in such stocks are either inefficient or non-existent. Result: the fund might not
be able to realize a fair price for exiting these stocks.

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All the Sensex and Nifty stocks are among the most actively traded stocks on
the bourses.

 Ultimate no-brainer in equity investing:

It is apparent that an Index Fund runs practically on auto-pilot, while
adhering to basic tried-and-tested principles of equity investing. Every single aspect
of fund management – choice of stocks, percentage holding in the corpus, and timing
of entry and exit – is pre-determined. It doesn’t require a fund manager’s
intervention. More importantly, the investor does not need to actively track his
investment in an Index Fund.
An Index Fund works on the premise that market capitalization will increase
with growth in the economy. The best representation of this is a broad-based Stock
Index like the Sensex and Nifty. In other words, it is the ultimate no-brainer in equity
investing.

 Low expenses
Index Fund is a less expensive form of investment than actively managed
funds. Index Funds do not require the services of high price portfolio managers,
analytical work of security analysts, etc. Portfolio management of Index Funds is
much less labor intensive than that of actively managed funds.

 Transaction costs
They are the charges incurred when one enters the market in order to buy or
sell securities. The burden of transaction costs depends on two factors:
 The average cost per transaction
It reflects both the broker’s commissions and the hidden cost, which is impact
cost. Impact Cost is the percentage degradation over and above the ideal price. For
liquid securities this cost is low while for illiquid ones it is high.

 Portfolio Turnover
As the objective of an Index fund is to mimic the Index, a fund manager does
not need to keep changing his portfolio like in the case of Active fund management.
He would need to change his portfolio only if there is a change in the Index

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constituents.
Thus, Index Fund is a low cost concept. These savings in costs, taken over a
long period of time, result in substantial gains for the investor.

 Difficult to consistently beat the market:

Though Active fund managers have been able to beat the market in certain
years, it becomes difficult to say whether they would be able to do so consistently.
Moreover, the underlying assumption of Indexed management is that financial
markets are efficient over the long term, making it virtually impossible for active
managers to consistently outperform market averages. Experience in the US has
shown that in the last 20 years, over 80% of the actively managed funds have
underperformed the benchmark S&P 500.

1.1.5. The Rationale for Index Funds

Traditional fund management has been based on the premise that the fund
manager adds value through continuous efforts at improving risk-adjusted returns by
forecasting returns. Index Funds are counter-intuitive in that they make no such
effort. The Index Fund manager makes no attempt at returns forecasting; his or her
only goal is to replicate Index returns.

1.1.6 The Mechanics of Index Funds

The stereotypical view of Index Funds is that their management is a trivial

task. Yet, in practice, there are significant challenges in the creation and operations of
an index fund.
Unlike active managers, who make no promises about future returns, Index
Funds promise to replicate the returns of a publicly observable Index. If the Index
rises by 20 percent, and if the Index Fund reports 19 percent returns, then the investor
is entitled to be suspicious about how a hundred basis points of returns were lost.
Index Fund management is a challenge because of this level of scrutiny and
accountability.

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 1.1.7 The Structure of Index Fund in India
The structure of an Index Fund is similar to a Mutual fund as it is floated by the Mutual funds
AMC.

STRUCTURE OF MUTUAL FUNDS IN INDIA:

In India, the mutual fund industry is highly regulated with a view to imparting operational
transparency and protecting the investor's interest. The structure of a mutual fund is
determined by SEBI regulations. These regulations require a fund to be established in the
form of a trust under the Indian Trust Act, 1882. A mutual fund is typically externally
managed. It is now an operating company with employees in the traditional sense.

Instead, a fund relies upon third parties that are either affiliated organizations or independent
contractors to carry out its business activities such as investing in securities. A mutual fund
operates through a four-tier structure. The four parties that are required to be involved are a
sponsor, Board of Trustees, an asset management company and a custodian.

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Sponsor: A sponsor is a body corporate who establishes a mutual fund. It may be one person
acting alone or together with another corporate body. Additionally, the sponsor is expected to
contribute at least 40% to the net worth of the AMC. However, if any person holds 40% or
more of the net worth of an AMC, he shall be deemed to be a sponsor and will be required to
fulfill the eligibility criteria specified in the mutual fund regulation.

Board Of Trustees: A mutual fund house must have an independent Board of Trustees,
where two-thirds of the trustees are independent persons who are not associated with the
sponsor in any manner. The Board of Trustees of the trustee company holds the property of
the mutual fund in trust for the benefit of the unit-holders. They are responsible for protecting
the unit-holder's interest.

Asset Management Company: The role of an AMC is highly significant in the mutual fund
operation. They are the fund managers i.e. they invest investors' money in various securities
(equity, debt and money market instruments) after proper research of market conditions. They
also look after the administrative functions of a mutual fund for which they charge
management fee.

Custodian: The mutual fund is required by law to protect their portfolio securities by placing
them with a custodian. Nearly all mutual funds use qualified bank custodians. Only a
registered custodian under the SEBI regulation can act as a custodian to a mutual fund.
With a proper structure in place, the industry has been able to cater to more number of
investors. With the increase in awareness about mutual funds several new players have joined
the bandwagon.

1.1.8 Disadvantages of an Index Fund

 One of the drawback which some of the index funds suffer is in the form of tracking
error.
 Theoretically, the return produced by an index fund should closely mimic the rise and
fall of concerned index.

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  But in reality, due to what we call tracking error, the fund may sometime generate
higher or lower than the actual movement in the index.
 Usually the cost of handling an index fund is low, but when an AMC charge cost
higher than the peers it can impact the total profitability of an investor.

1.1.9. Choice and Construction of Index

In many countries, "widely prevalent" share market indexes exist. In this case,
the modern development of the financial sector, in the direction of Index Funds or
index derivatives, almost automatically proceeds using these widely prevalent
indexes. These market indexes often present a host of awkward difficulties in modern
applications.

The revolution in computationalpower at ever-lower prices has made it possible to embed

complex computationalprocedures into day-to-day index management. Finally, research into
Index Funds andindex derivatives through the decade of the 1980s and 1990s has shed new
light uponthe issues in Index construction.

1.1.10. Methods of Implementing Index Funds

At first glance, implementing an Index Fund appears straightforward: the

index fund is supposed to buy stocks with the correct weights and trade in response to
changes in the Index set. In practice, implementing Index Funds proves to be a
significant challenge, especially when the underlying stock market Index has been
poorly designed.

The simplest method through which Index Funds are implemented is "full
replication," where the portfolio held by the Index Fund is the same as the Index.
Such an Index Fund will replicate the returns of the Index, subject to the caveat of
transactions costs in trading.

1.1.10.1. SENSEX - The Barometer of Indian Capital Markets

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SENSEX, first compiled in 1986, was calculated on a "Market Capitalization-
Weighted" methodology of 30 component stocks representing large, well-established
and financially sound companies across key sectors. The base year of SENSEX was
taken as 1978-79. SENSEX today is widely reported in both domestic and
international markets through print as well as electronic media. It is scientifically
designed and is based on globally accepted construction and review methodology.
Since September 1, 2003, SENSEX is being calculated on a free-float market
capitalization methodology. The "free-float market capitalization-weighted"
methodology is a widely followed Index construction methodology on which majority
of global equity indices are based; all major Index providers like MSCI, FTSE,
STOXX, S&P and Dow Jones use the free-float methodology.
The growth of the equity market in India has been phenomenal in the present
decade. Right from early nineties, the stock market witnessed heightened activity in
terms of various bull and bear runs. In the late nineties, the Indian market witnessed a
huge frenzy in the 'TMT' sectors. More recently, real estate caught the fancy of the
investors. SENSEX has captured all these happenings in the most judicious manner.
One can identify the booms and busts of the Indian equity market through SENSEX.
As the oldest index in the country, it provides the time series data over a fairly long
period of time (from 1979 onwards). Small wonder, the SENSEX has become one of
the most prominent brands in the country.

1.1.10.2. Timing of Changes

The Index is reviewed every quarter and a six-week notice is given to the market
before making any changes to the Index constituents.

1.1.10.3. Additions
The complete list of eligible securities is compiled based on the market
capitalization criteria. After that, the liquidity (impact cost) and free float filter are
applied to them, respectively. Short listed companies form the replacement pool. The
top stocks, in terms of size (market capitalization), are then identified for inclusion in
the Index from the replacement pool.

1.1.10.4. Deletions
Stocks may be deleted due to mergers, acquisitions or spin-offs. Otherwise, as

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noted above, every quarter a new eligible stock list is drawn up to review against the
current constituents. If this new list warrants changes in the existing constituent list,
then the smallest existing constituents are dropped in favor of the new additions.
The average total traded value for the last six months of all Nifty stocks is
approximately 62.45% of the traded value of all stocks on the NSE. Nifty stocks
represent about 60% of the total market capitalization as on Jan. 30, 2009. Impact
cost of the S&P CNX Nifty for a portfolio size of Rs.2 crore is 0.16%. S&P CNX
Nifty is professionally maintained and is ideal for derivatives trading.
S&P owns the most important Index in the world, the S&P 500 index, which
is the foundation of the largest Index Funds and most liquid Index futures markets in
the world.

1.1.10.5 Rebalancing

Index maintenance plays a crucial role in ensuring the stability of the Index, as
well as in meeting its objective of being a consistent benchmark of the Indian equity
markets.

IISL has constituted an Index Policy Committee, which is involved in the

policy and guidelines for managing the S&P CNX Nifty Index. The Index
Maintenance Subcommittee makes all decisions on additions/deletions of companies
in the Index.

1.1.11. Popular Indices on which Index Funds are built in India:-

 S&P CNX Defty

S&P CNX Defty is S&P CNX Nifty, measured in dollars. If the S&P CNX
Nifty rises by 2% it means that the Indian stock market rose by 2%, measured in
rupees. If the S&P CNX Defty rises by 2%, it means that the Indian stock market rose
by 2%, measured in dollars.

 CNX Nifty Junior

The next rung of liquid securities after S&P CNX Nifty is the CNX Nifty

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Junior. It may be useful to think of the S&P CNX Nifty and the CNX Nifty Junior as
making up the 100 most liquid stocks in India as with the S&P CNX Nifty, stocks in the
CNX Nifty Junior are filtered forliquidity, so they are the most liquid of the stocks excluded
from the S&P CNX Nifty.

The maintenance of the S&P CNX Nifty and the CNX Nifty Junior are synchronized
so that the two indices will always be disjoint sets; i.e. a stock will never appear in
both indices at the same time. Hence, it is always meaningful to pool the S&P CNX
Nifty and the CNX Nifty Junior into a composite 100 stock Indexes or portfolio.

 CNX Nifty
The scheme will invest in stocks comprising the S&P CNX Nifty index in the same proportion as in
the index with the objective of achieving returns equivalent to the Total Returns Index of S&P CNX
Nifty index by minimizing the performance difference between the benchmark index and the scheme.

Index Funds vs. Actively managed funds as on 1st March,2019

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1.2. EXCHANGE TRADED FUND (ETF):-

Exchange Traded Funds (ETFs), popularly known as ETFs, are hybrid investment
instruments, which combine the main characteristics of open-ended index funds and
ordinary corporate stocks. Like index fund, ETFs contain basket of securities
designed to track specific indices. And like stocks, ETFs can be bought and sold on a
stock exchange during trading hours on a real time basis, can be short sold, bought on
margin and can be purchased in as little as one share.

Index linked products, whether open-end mutual funds or ETFs, attempt to

replicate the returns and risks of the underlying market index. Theoretically, it appears
to be a very simple strategy, requiring passive fund managers to hold each constituent
index security in the same proportion to the benchmark (known as a ‘full replication’
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strategy). In reality however, index funds and ETFs experience considerable difficulty
in replicating the target index, because the index represents a mathematical
calculation that does not take into account market frictions. Accordingly, a passive
portfolio manager‘s objective must then be to implement an investment strategy,
which seeks to constrain the tracking error such that investors achieve returns that closely
approximate the target benchmark at minimum cost. Researches concerning ETF
performance have examined the magnitude and determinants of such tracking errors and
provided comparison between the performance of ETFs and their index fund counterparts
tracking the same underlying indices.

1.2.1. HISTORY AND DEVELOPMENT OF ETFs

These innovative financial products were first introduced on the U.S. and
Canadian exchanges in the early 90s. Officially, the Standard and Poor’s Depository
Receipts (SPDRs) is considered to be the first ETF which was created in 1993 in
order to replicate the performance of S&P 500 Index. In the first several years, ETFs
represented a small fraction of the assets under management in index funds. However
the launching of an ETF named cubes (or QQQ) in 1999 which follows the return of
NASDAQ 100 Index was accompanied by a spectacular growth in trading volume,
making ETFs the most actively traded equity securities on the U.S. stock exchanges.
Since then, ETF markets have continued to grow, not only in the number and variety
of products, but also in terms of assets and market value. Initially, they aimed at
replicating broad-based stock indices; however, new ETFs extended their fields to
sectors, international markets, fixed-income instruments and lately commodities.

In India, the first ETF was launched on National Stock Exchange in January
2002 by Benchmark Mutual Funds under the name Nifty Benchmark Exchange-traded
Scheme (Nifty BeES) which tracks the S&P CNX Nifty index. Since then the ETF
segment has grown slowly but steadily in India with a total of 31 ETFs being listed on
Indian stock exchanges with net assets of Rs.9641.83 crores as on 31st August 2011
as per SEBI estimates. Of these, the ETFs that are gaining popularity among the
Indian investors recently are the gold ETFs which attempt to replicate the returns of
gold without requiring the physical trade of gold on the part of investors.

23
Despite such a short history of ETFs in India, they have performed quite well
over these years. As per the findings of a study conducted by Singh and Gupta (2011)
to analyses the performance of ETFs in India, most of the ETFs have been able to
achieve their stated objective of nearly replicating the underlying index composition.
Though they have been found to experience statistically significant daily tracking
errors, there is no significant under or out performance over long term investment
horizon of half year or more. When compared against their index funds counterparts,
ETFs were found to perform better than index funds in all respects, namely portfolio
replication strategy, tracking ability and effectiveness over long term. Also, Indian
ETF market was found to be shallow in terms of the percentage of outstanding shares
traded each day, which averaged less than 1% for most ETFs. This could possibly be
due to lack of investor awareness regarding this relatively new financial product
available to them and is likely to be one of the important factors explaining the
significant pricing inefficiency in the Indian ETF market. Thus, there is a need to
build awareness among Indian investors regarding this innovative investment product,
which as an alternative to index mutual funds offer investors a low cost, flexible and
tax efficient way to track their favorite market segment.

While ETFs are available across a range of indices, commodities and other assets, the
main asset classes are typically the following:

 Equities – replicating the composition and performance of an equity index

(e.g. CNX Nifty, Hang Seng)
 Fixed income – government and corporate bonds covering a range of
timeframes (e.g. long-term, mid-term and short-term bonds), including some
that are income-producing (e.g. pay dividends)

ETFs can track underlying of various asset classes. Equity ETFs – Equity ETFs are
mostly index funds that replicate the composition and the performance of a target
index. These schemes invest in the securities in the same weightage as its target index
(e.g. CNX Nifty index, CNX Bank index)

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Money Market ETFs – Money Market ETF invests in a basket of call money,
short-term government securities and money market instruments of short maturities
while providing safety and liquidity.
 Commodity ETFs –Commodity ETFs enables investors to gain exposure to a
variety of commodities such as gold, silver, oil or broad based commodities index.
Among the first commodity ETFs were gold ETFs, which have been offered in a
number of countries and are gaining popularity in India as well. Broad based
commodity index include commodities from sectors as diverse as energy, metals,
agriculture and livestock.
The objective of such ETF is to track closely the physical price of the target
commodity. In India, only Gold ETF is currently available.

1.2.2. The ETFs types are as following:

 Market Index ETFs: Market ETFs usually track a major market index and are some
of the most active ETFs on an exchange floor, however there are some market ETFs
that track low-volume indexes as well. It has to be kept in mind that the goal of a
market ETF is to emulate an underlying index, not outperform it.

 Foreign Currency ETFs: Speaking of foreign ETFs, foreign currency ETFs help
investors gain exposure to foreign currencies without having to complete complex
transactions. Currency ETFs are seemingly simple investment vehicles that track a
foreign currency.

 Sector and Industry ETFs: Industry ETFs are types of ETFs that generally track a
sector index representing a certain industry. They are perfect for gaining exposure to a
certain market sector like pharmaceuticals without having to purchase the stocks of
individual companies.

 Commodity ETFs: Commodity ETFs are similar to industry ETFs in the fact that
they are targeted to a certain area of the market. However when one purchases a
commodity ETF like gold or energy, we do not actually buy the commodity, the ETF

25
consists of derivative contracts in order to emulate the price of the underlying
commodity.

 Derivative ETFs: There are some types of ETFs that do not consist of equities. Very
common with commodity ETFs, some funds are made up of derivative contracts like
futures, forwards, and options. While the goal is to emulate an investment product,
there are different ways to do so within the construction of ETFs. Assets in the fund
can either be individual companies or in these cases, derivative products.

 Style ETFs: Some types of ETFs track a certain investment style or market
capitalization (large-cap, small-cap, mid-cap). Style ETFs are most actively traded in
the United States and exist on growth and value indexes.

 Bond ETFs: The multitude of available bond ETFs runs the gamut. There are
international, government, and corporate to name a few. Bond ETFs have a difficult
task when it comes to construction since they track a low-liquidity investment
product. Bonds are not active on secondary markets since they are normally held to
maturity, yet ETFs are actively traded products on exchange floors.

 ETNs – Exchange Traded Notes: Exchange traded notes are the little brothers of
ETFs. While they are not truly a type of ETF, people still lump them into the major
ETF categories. ETNs are issued by a major bank as senior debt notes. This is
different from an ETF which consists of securities or derivative contracts. When we
buy an ETN, we receive a debt investment similar to a bond. ETNs are backed by
high credit rating banks so they are considered secure investment products, however
the notes are not totally absent of credit risk.

 Inverse ETFs: When the market starts to plummet, investors tend to want to get
short. However, trading account constraints can make that an issue. Margins may not
allow that possibility if one is selling a naked investment or there may be a restriction
on certain accounts against selling certain investments. Inverse ETFs are funds
created to create a short position when we buy the ETF. They have an inverse reaction
to the direction of the underlying index or asset.

26
  Leveraged ETFs: Leveraged ETFs are very controversial funds and are more suited
for the advanced ETF trading strategy. A common misconception is that they will
produce exponential annual returns, when in truth, they are constructed with the goal
of creating a leveraged daily return on underlying indexes and assets. And even then,
it is a goal, not an absolute.

 Actively Managed ETFs: In the ever going war of ETFs vs. Mutual Funds, there just
may be a compromise - Actively Managed ETFs. They combine all the benefits of
both mutual and exchange traded funds (ETFs) in one asset.

 Dividend ETFs: Some ETFs target equities that pay dividends. Usually dividend
ETFs will track a dividend index and the assets in the fund and index will consist of a
diverse range of dividend-paying stocks. In some cases, the dividend stocks will be
segmented by market-caps or geo-graphic locations.

 Innovative ETFs: With ETFs gaining popularity on a daily basis, there are more and
more innovations when it comes to these investment products. Some of the newer and
more innovative funds include ETFs of ETFs like Funds of Funds(FOF) Volatility ETFs and
Tax-Deferred,etc.

1.2.3. Indian Scenario

In less than two decades, Exchange-Traded Funds have become a major type
of investment around the world. As financial instruments go, ETFs are not very old.
The first ETF was launched in the US only in 1993 and in Europe in 1999. Today, a
huge USD 2.3 trillion of assets globally are deployed in ETFs. However, Indian
investors have almost completely ignored these funds. ETFs are index-based mutual
funds but are bought and sold like shares. ETFs are inherently very low-cost funds.
While an actively managed mutual fund often deducts expenses of up to 2.25%, ETFs
are generally in the 0.3% to 1% range. With compounding, this can build up to a
significant difference over time. While Benchmark is now in the news for having been
acquired by Wall Street superpower Goldman Sachs, nothing significant has

27
happened to the ETF business in India.

1.2.3.1. ETFs and INDIA

The first ETF in India, "Nifty BeEs (Nifty Benchmark Exchange Traded
Scheme) based on S&P CNX Nifty, was launched on December 28, 2001 by
Benchmark Mutual Fund. It could be bought and sold like any other stock on NSE. Its
symbol on NSE was "NIFTYBEES". Subsequently, with the takeover of the
Benchmark AMC Company by Goldman Sachs, it was called as “GS Nifty BeES”.
Over the time, other companies entered the market with their ETF products. There
were funds tracking the NSE Index – Nifty and BSE Index– Sensex. Other funds
focused on the commodity – Gold and some other leading indices.

1.2.3.2. Types of ETFs in India

 EQUITY ETF- Equity ETFs are mutual fund schemes, which combine the best
features of open ended and close-ended funds. They are like stocks, listed on NSE,
liquid, tradable throughout the day, priced continually and in demat form.

 GOLD ETF
A Gold ETF is a mutual fund scheme which is listed and traded on a stock
exchange like a stock. The investment objective of a Gold ETF is to provide returns
that, before expenses, closely correspond to the returns provided by the domestic price
of gold through investment in physical gold and gold related instruments. Gold ETFs
provide the opportunity to the investors to participate in the gold bullion markets
without the necessity of taking physical delivery of gold.
The history of Gold ETFs is started from Canada. The first Gold ETFs product
was “Central Fund of Canada”, a closed-end fund founded in 1961. It later amended
its articles of incorporation in 1983 to provide investors with an exchange tradable
product for ownership of gold and silver bullion. It has been listed on Toronto Stock
Exchange since 1966 and the AMEX since 1986. In India, the idea of Gold ETFs was
first conceptualized by Benchmark Asset Management Company Private Limited
when they filed a proposal with the Securities Board of India (SEBI) in May
2002.However it did not get approval at first and later in 2007, it was launched.

28
  The features of Gold ETFs
1. Gold ETFs can be bought in minimum quantity of one unit on a stock
exchange.
2. One unit represents approximately one gram of gold.
3. Units are held in a Demat account.
4. No securities transaction tax (STT) due to ETFs being classified as a debt fund.

 Benefits of buying Gold ETFs over physical gold

1. With Gold ETFs, you don’t have to pay additional costs like making or
delivery charges.
2. Quick and convenient dealing through a demat account.
3. No storage or security concerns for investors.
4. No issue of purity as gold purchased through an ETF is as per SEBI guidelines
and is subject to SEBI inspection.
5. ETFs can be easily bought or sold at any time during trading hours at
transparent, real-time prices.
6. For Gold ETFs, the long-term capital gains tax is applicable after one year,
versus three years for physical gold.
7. No wealth tax.
8. The underlying physical gold is stored with a SEBI registered custodian and
its quantity is physically verified by statutory auditors on a half yearly basis.

 WORLD INDICES- Exchange Traded Funds (ETF) that have as their underlying
tracking instrument an index or other financial product focused on a single country.
They are usually well diversified and designed to reflect the overall economic
condition of the country itself. The underlying index chosen is often the major index
of the principal exchange within the country.

 DEBT ETF- Debt ETFs that invest in bonds or debt securities are known as bond or
debt ETFs. They thrive during economic recessions because investors pull their
money out of the stock market and into bonds (for example, government treasury

29
bonds or those issues by companies regarded as financially stable). These ETFs are
linked to money or debt funds, with the aim of providing money market returns.
Liquid BeES (Goldman Sachs Liquid Exchange Traded Scheme) is the first
money market ETF in the world. The investment objectiveof the Scheme is to provide money
market returns. Liquid BeES will invest in abasket of call money, short-term government
securities and money marketinstruments of short and medium maturities. It is listed and
traded on the NSE.

 MotilalMOSt Shares N100 ETFwas based on the performance of the NASDAQ-100

Index.

ETFs have several advantages over traditional mutual funds, such as lower
expense ratios, trading flexibility, tax efficiency, transparency, and exposure to
diverse asset classes. Mutual funds have higher expense ratios than ETFs because of
entry and exit loads. It is pertinent to note that in India, entry loads for mutual funds
have been banned while exit loads do exist. ETFs are more tax efficient because of
their in-kind creation and redemption process, which allows for arbitrage and pricing
efficiency. In the case of ETFs, only the transacting shareholder is taxed, while the
gains are distributed to the other shareholders. On the other hand, the transactions of
mutual funds generate tax consequences for all the unit holders.

1.2.4. ETF TRADING MECHANISM

The ETF trading process is characterized by a dual structure, with a primary
market open to institutional investors for the creation and redemption of ETF shares
in lots directly from the fund, and a secondary market where ETF shares can be traded
with no limitation on order size. This structure has been illustrated in figure 1.
In the primary market, only Authorized Participants (APs), typically large
institutional investors who have an agreement with the fund sponsor, are allowed to
create new shares, in blocks of specified minimal amounts called creation units.
Creation units vary in size from one fund to another, ranging from 25,000 up to
3,00,000 ETF shares. The creation of these new shares is done “in-kind” by requiring
the AP to deposit a portfolio of shares that closely approximates the proportion of the
stocks in the underlying index at that time, together with a specified amount of cash

30
component to make up for the difference between the applicable NAV of the fund and
the market value of the portfolio deposits. A similar “in-kind” process is followed in
case of redemption of outstanding ETF shares whereby the redeemers (APs) are
offered the portfolio of stocks that make up the underlying index plus a cash amount
in return for creation units.

The number of outstanding shares tradable on the secondary market varies

over time according to creation and redemption operations carried out on the primary
market. Both institutional and individual investors can buy and sell shares in thesecondary
market like ordinary stocks at any time during the trading day. As such,
there is no fee payable for secondary market purchases or sales, but secondary market
transactions are subject to regular brokerage commissions.

31
Figure: 1. ETF Creation Process (NSE, India) Source www.nseindia.com

Since an ETF may be negotiated on two markets, it has two prices: the NAV
of the shares and their market price. The first price is the value per share of the fund’s
holdings computed at the end of each trading day. The second depends on the supply
and demand for shares on the exchange. If selling or buying pressure is high, these
two prices may deviate one from the other. However, the possibility of “in-kind”
creation and redemption ensures that departures are not too large. Conversely, if the price of
the underlying securities is lower than the ETF,the APs may create ETF units by depositing
the lower-priced securities. This arbitragemechanism eliminates the problem associated with
closed-end mutual funds namely,the premium or discount to the NAV.

1.2.5. Significance of Asset allocation

Asset allocation can be defined as a process of investing in a range of assets or
investments that are inversely correlated in order to diversify and reduce the
risk of the overall portfolio.

For example, adding an asset or an investment to a portfolio which is

negatively correlated with the portfolio as a whole, will potentially reduce the
volatility of the total portfolio.

1.2.6. Using ETFs to diversify your portfolio

 Asset allocation can be challenging given the costs and assets required to
achieve proper levels of diversification.
 ETFs can enhance portfolio diversification due to their ability to cover indices,
sectors, countries and asset classes.
 The range of ETFs available provides investors with the ability to build a
diverse portfolio that should meet their individual investment needs
(depending on their risk tolerance and investment timeframe).
 ETFs have relatively low expenses ratios enabling diversification at a low
cost.

32
1.2.7. ETFs and investor suitability

Given the flexibility, simplicity and transparency of ETFs, they have proved to be
popular, and are used by different types of investors to gain exposure to a variety of
investment strategies. These include:
Individual investor – ETFs offer the individual investor a cost-effective,
approach to gain diversification within their investment portfolio. ETFs are
especially beneficial to investors who like to make investments over a long
timeframe

Short-term investors – ETFs provide speculative investors the opportunity to

bet on an entire market as a single stock, taking advantage of market volatility.

Institutional investors – As ETFs are a relatively low cost investment vehicle,

institutions can use them effectively and efficiently to allocate their resources.

1.2.8. Positive Attributes of ETFs

1. Passive Management and Transparency of Portfolio

The purpose of an ETF is to match a particular market index, leading to a fund

management style known as passive management. Essentially, passive management
means the fund manager makes only minor, periodic adjustments to keep the fund in
line with its index, thereby mitigating the element of "managerial risk" that can make
choosing the right fund difficult. Rather than investing in a fund manager, an investor
buying shares of an ETF would thus be harnessing the power of the market itself.
Moreover, the passive nature of the funds also facilitates transparency of portfolio
since there is little desire on the part of fund manager to maintain secrecy over his/her
investment strategy. Indeed, by enabling investors to know the underlying portfolio
combination on a daily basis, ETFs are even more transparent than the index funds
which disclose such portfolio composition on a monthly basis.

33
 2. Exchange Trading

Perhaps the most immediately striking characteristic of ETFs is their

eponymous innovation: the ability to trade like a typical security throughout the
business day at real-time prices on a stock exchange. Prior to the advent of ETFs, an
investor seeking broad market or sector diversification via a single investment
instrument would be limited to mutual funds, which are priced just once a day.
Investors in mutual funds thus, have no way of reacting to positive or negative news
during the business day. With ETFs, however, investors can react immediately to
positive or negative news by purchasing or selling ETF shares as soon as they receive
the information. A savvy and responsive ETF investor may thus be able to profit from
rises or to avoid declines in the market through swift ETF transactions.

3. Flexibility

ETF shares resemble stocks and provide flexibility to investors in other ways
as well. Investors can, for example, place market, stop, or limit orders on ETF shares,
thereby exerting a good deal of precise control over the purchases and dispositions of
the holdings in their portfolios. In the same way, investors may also sell ETF shares
short in order to bet against the movements of broad market indices or to hedge
against the performance of other holdings in their portfolios. Similarly, investors may
purchase ETF shares on margin and buy or sell options on ETF shares. Such
flexibility in trading is however missing in case of mutual funds.

4. Lower Costs

Because of the nature of their structure and management, ETFs generally

charge low fees and expense ratios, which further endear them to investors. ETFs that
passively track broad market indices have relatively little need for management by
human portfolio managers. Accordingly, ETFs suffer very few of the transaction costs
associated with the turnover of portfolio securities. Even when compared to passively
managed index mutual funds, ETFs experience relatively less turnover of portfolio
securities due to its unique in-kind creation and redemption process. This in-kind
process also saves ETFs from the cash-drag experienced by index fund that need to

34
keep a certain proportion of assets un-invested to meet redemption needs. Moreover,
being exchange traded products, ETFs incurs lower expenses in terms of
shareholder’s accounting, marketing and distribution as compared with many
traditional mutual funds.

5. Tax Advantage

Passive management is also an advantage in terms of tax efficiency. ETFs are

less likely than actively managed portfolios to experience the trading of securities,
which can create potentially high capital gains distributions. Fewer trades into and out
of the trust mean fewer taxable distributions, and a more efficient overall return on
investment. Moreover, since in-kind redemption is not considered a taxable event, no
capital gain tax accrues at the time of redemption.

6. Suitable for Broad Class of Investors

ETFs are suitable for a broad class of investors; be it a short term investor
looking to cash in on intraday volatility, a long term investor who wants to be
insulated from short term trading activities of other investors, a retail investor looking
for low initial investment, or a large investor looking for low cost, liquidity and all the
benefits of index tracking.

1.2.9. Limitations of ETFs

The unique structure of ETFs provides an edge over its mutual fund
counterparts in many aspects, as discussed. However, like any other financial
innovation, ETFs too have its share of criticism. These are discussed as follows.

1. Investor Transaction Cost

Although, the most striking feature of ETFs of being traded at stock exchanges
has many advantages, the fact that retail investors must buy and sell ETFs on
exchanges means that such investors will have to pay brokerage fee and also bear the

35
burden of absorbing costs that results from bid and ask spread - that is, the gap
between the price buyers are willing to pay and sellers are willing to accept.
These trading costs may be amortized into relative insignificance if an investment is held for
many years. However, for more active traders, or for the investors following a saving
strategy that involves purchasing a relatively small amount of investment at regular
intervals, such ETF transaction cost may work out to be high enough to eat up much
of their expense advantage over mutual funds.

2. Short-Term Speculations

Critics of ETFs argue that the flexible trading rules of these funds creates an
environment that fosters a short-term trading mentality using indexed instruments that
were designed for long term investment, and that investors use the trading features of
ETFs to chase the hot funds or sectors, not to match the performance of an index.

3. Tracking Error

Perhaps the most fundamental shortcoming of an ETF or an index fund is its

failure to perfectly replicate the returns of the index to which it is benchmarked. The
extent to which the fund performance differs from the underlying benchmark index is
assessed by quantifying the level of tracking error. These results from factors such as
transaction costs, fund cash flows, dividends, benchmark volatility, corporate activity
and index composition changes.

CHAPTER II

2. RESEARCH METHODOLOGY:-

2.1 Introduction

36
The present research is an attempt to study the presence of Index Funds and Exchange Traded
Funds (ETFs) in India. With a view to develop a sound theoretical framework for
investigation, Review of Literature relating to awareness evaluation of Index Funds and
Exchange Traded Funds (ETFs) has been done in following chapters.
An Index fund follows a passive investing strategy called indexing. It usually
holds stock in the same proportion as that in the represented index. The objective of index
funds is to track the ideal market index or their ideal portfolio. Many of the index funds also
invest in derivatives such as futures and options. Some Index funds are invested in
indices companies as same ratio as they were included in indices while some index
funds only invest in all companies as sample.
An ETF is made up of stocks making a particular index like Sensex or Nifty. Each of the
stock would have the same weight-age as it has on the index. Some portion of its assets may
be held in cash or money market securities for liquidity purpose. Returns of an ETF are
usually close to that of the index. However since the percentage of debt or liquid assets varies
with ETF so does return from different ETFs thought they all track the same index.

2.2. Objectives:-

The objectives of the study are

1. To evaluate the awareness of Index Funds and Exchange Traded Funds(ETFs).

2. To identify the trends of Index Mutual Funds and Exchange Trade Funds (ETFs)
and Gold ETF.
3. To conduct a comparative analysis of Index Funds and Exchange Traded
Funds (ETFs).

2.3. Research Methodology:-

2.3.1. Universe of Research

37
The masses approached during this research are the retail investors which are mainly middle
class portion of population. The research was conducted to get an insight about retail
personnel knowledge about new products in the market and their approach towards it.

2.3.2. Method of sampling

While collecting samples, utmost care has been taken that it should reach only to the universe
of research and not further. Method included the use of a forwarding and filling up of a
questionnaire from the retail investors. The questions asked during collection of data are
mentioned in project Annexure.

2.3.3. Sample Size

Sample size for the research conducted is standard i.e. 100(more but not less) in order to get
an estimate of retail investor psychology.

2.3.4. Method of Data Collection

This study is completely based on the primary and secondary data. This data is collected
from various source such as Stock exchanges, SEBI, Value Research Magazines,
journals, articles, books and the published and unpublished documents of the mutual
funds have been considered in the research.

The data was collected from the ICRA, the Stock Exchanges, and the
respective fund houses. The monthly closing prices of benchmark index, prices of
gold and NAV of the funds was taken from the National Stock Exchange (NSE) and
the Bombay Stock Exchange (BSE), AMFI, etc.

2.3.5. Method of Primary Data collection

38
Primary Data has been collected by approaching the retail investors and requesting them to
fill the questionnaire (mentioned above) according to their choice. Due care is taken that the
questionnaire form has been handed only to the universe of research i.e. the retail investors
and not further.

2.3.6. TOOLS FOR ANALYSIS

For the purpose of analysis of data various statistical tools are used. To
understand and analyze the awareness of Index Fund and ETFs, tools used are namely bar
chart and pie diagram and percentage method to see a clear analysis of data collected.

2.4. Importance of Study:-

Indian mutual fund industry presently valued at about $190.4 Billion,

witnessed an addition of 2.2 million new investors during financial year 2015. Both
ETFs and mutual funds are viable choices for investors, but with so many available on
the market, it is important for investors to familiarize themselves with the differences
between products to ensure they are making appropriate investment decisions. While
mutual funds and ETFs share similar traits, there are differences between the two that
investors must consider when deciding which to use.

Both the index fund and the exchange fund industry in India are still young.
Relatively little is known about the long term performances of both these funds.
However a systematic effort to measure and compare the various aspects of their
performances, using a consistent methodology, has not been undertaken. The short
history with index funds in India implies that relatively little data is available. Yet, it
is important to utilize this limited evidence in order to understand the limitations of
indexing in India. Index funds have attracted considerable attention in India. Most
major fund houses have already launched index funds while many others are on way
to launching. From the perspective of investors, the current study helps in assessing

39
the extent to which index funds deliver on their promise of exactly tracking the index
in comparison to their ETF counterparts.

Thus, this research will present a long term view on the performances of index
mutual funds as well as equity ETFs and Gold Exchange Trade Funds (GETF) that
could be useful for further researches.

2.5. Limitation of Study

The study limits itself to Index funds, equity ETFs and Gold ETF Schemes of
mutual fund companies and examine the growth performance of passive mutual
fund’s product, behavior of returns and comparative analysis of ETF and Index
Mutual Fund schemes in India. This chapter attempts to discuss the research
methodology used for the study by elaborating sampling design, data collection, data
analysis, the research tools used and limitations of the study. Also, the collected data can be
biased.

CHAPTER III

3. REVIEW OF LITERATURE

Exchange Traded Funds have a brief history. ETFs have not faced extended researching
interest. The literature presents very few records of studies related to this issue, particularly in
empirical level. The most significant papers are introduced in this chapter. The literature can
be subdivided into the following categories.

Studies related to ETFs in general, covering description of ETFs, demonstrating the tax and
other certain advantages of ETFs in comparison to traditional mutual funds.

40
Studies providing an introduction to ETFs, focusing on their origin, describing their main
types and the exchanges where they are (or were) traded, analysing their characteristics and
operating mechanism. They also indicate the benefits the participants of capital markets gain
by ETFs‘ existence.

Some papers compare ETFs and index funds, demonstrating that the main differences among
them are related to management expenses, transaction fees and tax efficiency. They also
suggest that the tracking error‘s comparison between ETFs and index funds is difficult
because of the lack of a true benchmark for comparison.

Some authors study performance and the trading characteristics, performance is studies by
applying Sharpe ratio, Treynor ratio and Jensen alpha and trading characteristics are studied
by investigating the ability of ETFs to accurately replicate the performance of their
underlying indexes, for finding the existence of tracking error, In parallel, they study whether
the ETFs are trading at their NAVs, to find whether they trade at a premium from their net
asset value or discount to their NAVs.

Few authors try to compare the performance of ETFs with that of broad market index, to
prove that a portfolio of passive ETFs can provide above market returns with the least risk
assumed. They also study the performance persistence of ETFs over the market index.

Few other compare the performance of Active (vs) Passive ETFs by applying the Jensen‘s
Alpha as a performance measure. The literature is discussed below:-

Gerasimos G. Rompotis(2008) The performance and the trading characteristics of 62 German

Exchange Traded Funds during the period 11/04/2000-12/09/2006 are investigated in this
paper. Using weekly data we find that, on average, German ETFs slightly underperform their
benchmarks and encumber investors with greater risk than indexes. Also found that a number
of 26 ETFs of the sample do not follow full replication strategies resulting in a substantial
mean tracking error of 1.07%. By regression analysis, it is revealed that the tracking error is

41
positively affected by risk, bid-ask spread and management fees. Additional research shows
that the expense ratio relates positively to volatility, absolute premium and bid-ask spread,
and relates negatively to assets. The negative relationship among expenses and assets reveals
the achievement of economies of scale when the size of ETFs increases. In addition, the
tracking error, expense ratio and absolute premium are found to positively affect the bid-ask
spread. Finally, in regression results we find that the weekly risk of ETFs positively
influences their trading volume while a significant portion of volume is unexplained.

Benchmark Funds Asset Management Company(2008)28 research department did research in

early 2008 on the topic of ―Myth of Eternal Alpha‖ It has often been argued that individual
active fund managers are consistently able to exploit anomalies and aberrations that may exist
in the market and while considering out performance/ under performance one should look at
longer periods.

Svetina and Wahal (2008) study a sample of 584 domestic equity, international equity, and
fixed income Exchange Traded Funds from their inception to the end of 2007. The basic
objective of their study is to analyze the performance of ETFs and the nature of competition
created by them for index mutual funds and for the incumbent ETFs. The findings show that
on average, ETFs underperforms their benchmark indices and are not immune from tracking
error. A comparison of ETFs and index funds reveal that almost 83 percent of all ETFs track
indices for which there are no corresponding index mutual funds. These ETFs generally track
esoteric non-mainstream indices, effectively expanding the passive investment opportunity
set for investors. ETFs that compete directly with index mutual funds deliver slightly better
performance when compared to retail index funds and equivalent to the performance of
institutional index funds. Thus, while providing at least comparable performance, ETFs also
provide immediacy. The impact of this is that the entry of ETFs that track the same index as
incumbent index funds reduces net flows to index mutual funds. Moreover, they find that the
introduction of competing ETFs permanently reduces the demand for incumbent ETFs in the
same asset class and investment style category.

J.Gayathri and P.Bhuvaneswari (2009). This paper examines the performance of ETFs listed
on NSE from 2005 to year by comparing the returns and risk of the ETFs with the return and
risk of the index. Sharpe ratio and Treynor ratio were used. The result showed that NIFTY
BeES was the best performer.

42
Gerasimos G. Rompotis (2009) This paper expands the debate about ―active vs. passive‖
management using data from active and passive ETFs listed in the U.S. market. The results
reveal that the active ETFs underperform both the corresponding passive ETFs and the
market indexes. With respect to risk-adjusted returns, both active and passive ETFs provide
investors with no positive excess returns, an expectable finding for the passive ETFs but not
for the active ETFs which are aimed at beating the market. Going further, the
underperformance of active (2009) ETFs is depicted to the low performance rates such as the
Sharpe or the Treynor ratios they receive relative to the passive ETFs and the indexes.
Furthermore, regression analysis on the selectivity and market timing skills of ETF managers
indicate that the managers of both the active and passive ETFs are lacking in such skills.
However, the passive managers are not expected to have such skills. Finally, tracking error
estimates indicate that the discrepancy between ETF and index returns is greater for active
ETFs However, this result is to be expected as the active ETFs do not target to replicate the
performance of the indexes.

Stijn Zweegers (2010). The extended Sharpe ratios of the ETFs are directly tested to the
extended Sharpe ratios of the mutual funds. Both investment strategies did not outperform the
benchmark according to the extended Sharpe ratio, since the average ratios both are negative.
The actively managed mutual funds did however outperform the passively managed ETFs
according to a T-test with a significance level of five percent. Meaning that according to the
extended Sharpe ratio, investing in mutual funds would have been better over the evaluation
period than investing in ETFs. Given that the mutual funds give a better return relative to
their risk. Mutual funds did not significantly outperform the benchmark according to the
Jensen‘s alpha since they have a negative average alpha tested at a significance level of five
percent or less. The overall managers‘ goal is not accomplished. However, the mutual fund
managers did significantly outperform the alternative investing strategy, ETFs. The T-test
shows a significant outperforming with a significance level of five percent. The overall
conclusion of this papers research is that the active mutual funds managers outperformed the
passive ETFs managers.

P. Natarajan and M. Dharani(2010) Nifty BeES is the first Exchange Traded Funds in the
Indian Capital Market and its daily returns are compared to benchmark returns. The
Researcher found out that Nifty BeES basically over-performed their benchmark while they
endorsed their investors with lesser risk than the standard deviation of the Nifty Index.
Further, this paper analyses the relationship between portfolio returns and market returns by

43
using Simple Regression Model. The Researcher discovered that returns of the Nifty BeES
for price was not related to the index returns, but returns of the Nifty BeES for NAV was
related to the index returns. This was due to the price of the Nifty BeES in the secondary
market being based on supply and demand while NAV of the Nifty BeES was based on the
underlying index. Finally, this paper examined the observed deviation between returns of the
Nifty BeES and Nifty Index. Applying three methods, the Researcher concluded that the
average tracking error fluctuates from approximately 0.59% to 0.907% for price and 0.049%
to 0.549% for NAV. All the methods, which were used in this study for calculating tracking
error, did not produce the same results. During the study period of 6 years, portfolio returns
of the Nifty BeES beat the market returns and hence it can be considered as one of the
investment products in the promising Indian capital market

Prashanta Athma and Raj Kumar(2011) The study covers the trends and progress of ETFs
and Index Funds in India and to evaluate the performance of ETFs vis-à-vis Index Funds in
India. The study is based on secondary data and covering the period of five years from 2005
to 2009 for the purpose of evaluating performance of select ETFs and Index Funds in India.
Since inception, the data has been collected for the purpose of analyzing trends and progress
of ETFs and Index funds in India. The parameters for evaluating the performance are Net
Asset Value, Risk, Return, Expenses Ratio, Tracking Error, Reward to Variability and
Differential Return. The statistical tools like Standard Deviation, Beta, Alpha, R-squared and
Sharpe Ratio are used for data analysis. It is concluded that ETFs have given better
opportunity for the small investors in terms of diversified portfolio with a small amount of
money; low expense ratio, reduced tracking error, lower risk and volatility as compared to
Index Funds. The ETFs can become a best investment alternative, provided, awareness is
created among the investors.

Pedro Kono , Pan Yatrakis ., Sabrina Segal (2011) This study tests the market efficiency of
the Japanese equity market. The analyses compare the performance of a portfolio consisting
of exchange-traded funds (ETFs) with that of the overall market, exemplified by the Topic
Index, during the period of June 30, 2008 to June 30, 2009. The ETF portfolio is constructed
according to the Modern Portfolio Theory (MPT) developed by Harry Markowitz in 1952.
The study concludes that an optimal ETF portfolio can outperform an overall market index
when performance is measured using the Sharpe ratio, i.e., the return per unit of risk.

44
Alok Goyal and Amit Joshi (2011). This paper studies the financial performance, variations
and also analyses the risk behavior of the selected Gold ETFs in comparison of NSE. The
data for this has been taken from the NSE website. The period taken for the study is March
2008 to November 2010. Analysis is made by using financial tools like Sharpe‘s index,
Treynor‘s ratio by calculating alpha, beta and standard deviation of the selected funds.

DR.PRASHANTA ATHMA and MS SUCHITRA K (2011) This paper stresses upon the
inclusion of Gold ETF in a portfolio for risk diversification; to assist the investor in the
selection of best Gold ETF option and to analyze the tax implications of Gold ETF. Simple
statistical tools like Averages, Standard Deviation and Coefficient of Variation are used. For
the construction of portfolios, three most actively traded securities namely Reliance
Industries Ltd, ICICI Bank Ltd and State Bank of India (SBI) are taken as one portfolio and
the other portfolio includes Gold ETF and top two actively traded securities in order to reflect
upon the effect of inclusion of Gold ETF in a portfolio.

DR. PREETI SINGH (2011) in this paper ETFs are compared with Mutual Funds. It had been
found from all the above discussion that ETFs are more reliable than mutual funds. If the
present situation of the world is analyzed most of the trading is taking place on barter system.
Individuals having one particular good wait for the proper time by analyzing the market trend
and then sale it in exchange of the money or other goods. Majority of the world‘s population
do not hold precious assets what they can invest into the business. Rather majority belongs to
subclass or poor community which has to earn money rapidly to meet their basic needs.
Keeping all these aspects in mind Exchange is the better option rather than availing the
mutual funds which are more expensive and more time consuming. While considering the
managers of mutual funds investments, there are more chances that managers may exploit the
interests of investors by not letting them know properly about their current status. Also in
case of mutual funds there always are conflicts of interests, the reason behind could be it is
very hard to manage a big investment than managing the small investments as is in the case
of exchange trade funds. There are few things necessary to observe before on enter into the
exchange trade. Exchange trade is the derivative of index fund that totally operate on the
basis of previous market values and trends. Before investing it should be clear in one‘s mind
that he knows all the steeps and slops of market values or if some trading agent got to be
involved he should have tremendous grip on the market flow and twists. By considering all
the above mentioned facts it is found that exchange trade is the most appropriate trade as it
bears less expenses have more risks but less loses. Also it is friendly to the traders having less

45
capital in hand. Exchange trade follows the market trends the money of investors can be
liquefied according to desires whenever there is need to buy or sell the stock. Hence the
easiest and convenient way of making money through trade is the exchange trade fund and is
gaining the popularity due to its flexible mode of operation.

Reena Aggarwal (2012) Exchange traded funds (ETFs) are one of the most innovative
financial products introduced on exchanges. As reflected by the size of the market they have
become popular among both retail and institutional investors. The original ETFs were simple
and easy to understand, however some recent products such as leveraged, inverse, and
synthetic ETFs, are complex and have additional dimensions of risk. The additional risks,
complexity, and reduced transparency have resulted in heightened attention by regulators.
Concerns related to systemic risk and excess volatility, suitability for retail investors, lack of
transparency and liquidity, securities lending and counterparty exposure, among others have
been raised. These concerns are being addressed by a shift towards multiple counterparties,
overcollateralization, and disclosure of collateral holdings and index holdings. The
appropriate regulatory and market reforms can ensure the continued success of ETFs.

Harip R. Khanapuri(2012) Exchange traded funds (ETFs) have completed a decade of their
presence in Indian capital markets although their popularity has grown very recently. Since
the ETFs are issued on the basis of their underlying assets, their price movements are
supposed to follow those of the underlying index or other assets they represent. The paper
evaluates movement between prices of ETFs in India and those of their underlying assets
using the econometric technique of Vector Auto regressions. The findings suggest that while
movements are stronger in equity based ETF, such relation does not exist in commodity
based ETF markets. The findings have significant implications on investment style to be
adopted by investors in ETF market.

P. Krishna Prasanna (2012) the concept of Exchange-Traded Funds (ETFs) is very popular in
foreign countries, but in India, it is still in the initial growth phase. This research paper
examines the characteristics and growth pattern of all the 82 exchange traded schemes floated
and traded on Indian Stock markets, and evaluates their performance using Data
Envelopment Analysis (DEA). On an average, ETFs grew at 37% annually during the period
2006 -2011in India. These funds consistently outperformed the market index and generated
higher returns. ETFs generated excess returns of 3% p.a. as against CNX NIFTY, which is
the Indian equity market bench mark. Gold ETFs provided 13% excess returns as compared

46
to the returns on the equity market and attracted large investments in the post financial crisis
years. Data Envelopment Analysis ranked domestic and overseas fund of funds as efficient
funds, which were floated by foreign Asset Management Companies (AMCs) efficient funds
are found to have higher Sharpe ratios, indicating that the DEA ranking is in broad consensus
with the evaluation done using Sharpe ratios. However large funds were not found to be
efficient funds. This infers that the fund size does not indicate superior performance

Dr. Kaushal Bhatt (2012) Investment is the commitment of funds by buying securities or
other monetary or paper (financial) assets in the money markets or capital markets, or in
fairly liquid real assets, such as gold, real estate, or collectibles. An investment can be
described as perfect if it satisfies all the needs of professional investors. There are large
numbers of investment avenues for savers. Some of them are marketable, liquid, while others
are non-marketable. This paper addresses Exchange Traded Funds (ETFs), the index
investments that are a cross between exchanges listed corporate securities and open-ended
mutual funds. While ETFs are now competing with mutual funds, they have a very different
history and operational structure. It is important for investors to know the difference between
mutual funds and ETFs and few investors fully understand ETFs. This paper focuses on
conceptual and theoretical aspects of ETFs in India. It covers its comparison with mutual
funds

Shefali Sinha and Mahua Dutta (2013) Goldman Sachs Asset management (India) Private
Limited is the first mutual fund house which came up with the concept of scheme of Gold
exchange traded fund in 2007. As, the scheme's performance is directly related to the
domestic price of gold. Its growth over a period of time is not reflected by some of the
research studies. The study was undertaken to fill the research gap with emphasis on
determining the potential of generating the performance returns of scheme of Goldman Sachs
Gold exchange traded fund from the period 2007-2012. The main objective of the study (a) to
identify the performance of returns of Net Asset Value for the period (b) to identify the
performance of returns of domestic price of Gold for the period (c) to determine the trend
analysis of computed Net Asset Value returns and (d) to determine the trend analysis of
domestic price of gold returns. The hypothesis in this study involves growth rate of Net Asset
Value returns & domestic price of gold returns. For this purpose, secondary data was
collected historical net asset value prices & domestic price of gold for the period 2007-2012.
Computation of daily net asset value returns & domestic price of gold returns is taken into
account for five years to identify the tracking error. The methods used for interpretation of

47
data in the study are tracking error and trend analysis. The trend analysis shows that the net
asset value returns are in close proximity with domestic price of gold returns through tracking
error. Lower tracking error indicates the better performance of the scheme.

Swati Garg & Dr. Y. P. Singh (2013) this paper empirically compares the performance of two
competitive financial instruments available to Indian investors, namely Exchange Traded
Funds (ETFs) and Index Funds. A set of five ETFs and Index Funds that in pairs track the
same benchmark indices has been analyzed in this study over a period ranging from June
2006 to December 2009. The analysis demonstrates better performance of ETFs in terms of
their replication strategy, tracking ability as well as performance effectiveness over long-term
investment horizon. However, there is an evidence of potential disadvantage of ETFs from
very short-term investor’s point of view.

SURESHA.B (2013) Price risk is the major risk faced by all investors. Although price risk
specific to an underlying can be minimized through diversification, market risk cannot be
diversified away. Price risk depends on the volatility of the underlying held within a
portfolio. In this study an attempt has been made to test the volatility of Gold ETF in India.
Sample 14 listed Gold ETFs of NSE were taken to measure the volatility. The study also
investigates the price risk associated due to inter correlation factors which are un-
diversifiable. Annualized Actual Volatility (AAV) model is used to calculate volatility and t
test is computed for significance. GOLDBEES, GOLDSHARE, KOTAKGOLD, RELGOLD,
SBIGETS have highest (significant at 1%) price volatility as compared to other counterparts
and poses higher price risk to the investors. AXIS, HDFCMFGETF, IPGETF,
QGOLDHALF, RELIGAREGO have moderate price volatility at 5% significance level.
Interestingly, BSLGOLDETF, IDBIGOLD, MGOLD, CRMFGETF have least insignificant
volatility and indicate the least price risk among the samples ETF. The correlation among
these samples Gold ETF is positive except in case of CRMFGETF. Knowing the volatility
helps in deciding possible range of values that an underlying will be in and when an investor
knows how much volatility he is exposed to, he can make informed decisions on his
investments.

48
Chapter IV

Analysis & Interpretation

4. ANALYSIS AND INTERPRETATION OF DATA

4.1 Analysis of Data Collected:-

1. Age

49
It has been seen that, Age group of 20-60(i.e. 20-40 & 40-60) are more aware of the newer
products floating into the market.

This age group comprise of actively working population. It is the earning population.

Earning population knowing about the products like ETFs and Index Funds can be a positive
sign on the development of this products.

2. Profession

50
Here, it’s been observed that, majorly students and salaried employees are aware about ETFs
and Index Funds as products.

In a country like India, salaried employees are less than compared to other forms of
employment. It is a bonus that the personnel that would take up jobs in future are aware about
the products which ensures the development prospect of the Industry.

Attention to awareness should be given to employees of non-salaried class too in order make
growth even higher in ETF and Index Fund market.

3. Capital invested in market

51
As, the responses/data collected were of retail investors, the groups were made accordingly-
below 1 lakh, 1-5laks, 5-10 lakhs, 10 lakhs and above.

The result conveyed the message that more retail investors have capital invested in market of
about 1 lakh (almost50%).

Majority chunk of the respondents have capital below 5 lakhs invested in markets.

Since it is retail class and considering the awareness among students and broader untapped
market, capital is only likely to increase into this segment of market over the years.

4. What kind of investor you think you are?

52
Here, it was a personal analyzing question put forth for the respondents

The majority chunk of the respondents came out with conclusion that they are moderate risk
takers.

Also a considerably respondents choose risk takers as their type which were mostly young
and some choose risk averse type conveying the conservative approach towards market.

53
 5. Rate the importance of liquidity (convertibility to cash) to you.

This question was asked to get a jist of respondents preference on liquidity.

Here, ratings were given for liquidity- 1 being the highest importance of liquidity and 5 being
the lowest.

Out of the responses collected major chunk gave importance to liquidity in their investments.
It shows that the retail investors are much concerned about the convertibility of cash.

6. How much volatility (swing in prices) do you prefer in your

investment?

54
This question was asked to get a jist of respondents preference on volatility.

Being retail persons, majority of the respondents opted for the moderate to low volatility
scenarios on their investments.

Some selected high volatility for their investment conveying their risk taking approach.

7. Where did you get to know about ETFs and Index Funds?

55
It was a general question as to where from the respondents got to know about this market
segment.

The collected responses were appropriately dispersed. About 36% people came to know
about it via news and articles, 24% from friends and family, 20% from advertisement, etc.

8. Are ETFs and Index Funds type of Mutual Fund?

56
It was a question put forth to test the knowledge of the retail investors about ETFs and Index
Funds

Majority chunk of respondents didn’t knew about the category into which the ETFs and Index
Funds belong to. Others tried to their extent.

9. In what proportion do you allocate your funds in ETF/Index Fund in

your portfolio?

57
Here, the respondents were asked to convey about their proportion of holding of ETFs/Index
Funds in their portfolio.

Many of them did not have any exposure to ETFs or Index Funds.

Majority of respondents had their holdings about 10% and below in ETFs and Index Funds in
their respective portfolios.

It conveys a positive sign on acceptability of this market segment and hints for growth and
rise in holding proportion in coming years.

10.According to you which one is easier investment option? Why?

58
It was a general question posted for the respondents to get information on which of the
investment option is actually is easy to invest in.

Majority opted for Index Funds as an easy avenue to invest.

It is due to retail mentality, easy to understand structure of the product, pitching of the agents,
etc.

Many responses came with other investment suggestions that respondents think are easy to
invest in like MFs, insurance, etc.

59
 11.Would you think of buying ETFs/Index Funds instead of Equity
shares?

It was a question given for the respondents to get to know about their preferences among this
market segment and traditional equity market.

The analysis is open and shut kind of information. Many of them were confused, about 47%
opted for ETFs/Index Funds over equity.

It would not be easy for this market segment to be the first choice of investors.

60
 12.What you think of popularity of ETFs & Index Funds as an
investment product?

It was a general question posted for respondents to get an idea about the depth, accessibility
and popularity of this market segment among retail investors.

Majority of chunk responded that this market segment is undervalued as far as their
popularity is concerned.

Thus, it can be concluded that this market segments are yet to known among broader chunk
of population which hints immense potential of growth in this segments.

13.If given a chance to invest, what will be your preference among the
two asset classes? Why?

61
It was a choice based question put forth for the respondents.

Majority (about 62%) of respondents choose Index Fund over ETF to buy if given an option
to do so.

It maybe because of easy accessibility, easy to understand structure of Index Funds, less tax
rates, pitching of the advisors, trust on the product, etc.

4.2. ETF and Index Funds  – Similarities

62
There are some factors which make both ETF and Index funds similar in nature and stated
below:

 Both Index Funds and ETFs are classified under the head of ‘indexing’ as it involves
making an investment in an underlying benchmark index. The objective is to beat
actively managed funds in multiple ways.
 They have low expense ratios compared to actively managed funds
 Funds are managed professionally and aim to reduce risks through diversification.
 They have a Net Asset Value determined as Total Value of the Underlying assets
minus Fees / Total Number of Shares

4.3. ETF and Index Funds Comparative Table

Sr. Basis for comparison ETF Index Fund

No.
1. Meaning Fund tracking indexes of a Fund replicating the
specific exchange. performance of a benchmark
market index.
2. Base It will trade like other stocks It is like Mutual Fund
3. Pricing difference Done at the end of the day Traded on intra-day basis
depending on the stock price
movement
4. Basis for pricing Demand and supply of the NAV of underlying asset
security/stock in the market
5. Trading costs Higher costs No transaction fee/
commission
6. Expense ratio Low Comparatively higher
7. Initial investment No minimum investment Can be a few thousand bucks
8. Settlement time 3 days 1 day

4.4. Understanding Tracking Error and Tracking Difference

According to the Black Rock Inc., there are two common measures used to

63
evaluate the performance of an ETF – "tracking error" and "tracking difference".
While both are useful indicators of deviation from benchmark performance, they
measure different characteristics. Understanding both performance metrics is
therefore very important.

Tracking difference is simply the return difference between the ETF and its
underlying index over a given time period while Tracking error is the volatility (as
measured by standard deviation) of that return difference. So while tracking
difference tells us how much the performance of an ETF can deviate from its
underlying index over a given time period, tracking error shows the consistency of
returns relative to the index throughout this entire time period.

4.5. Things to consider as an Investor

a. Risk tolerance 

As discussed earlier, since index funds map an index, they are less prone to equity-related
volatility and risks. Index funds are amazing options during a market rally to earn great
returns. However, you need to switch to actively-managed funds during a slump. It’s because
index funds may lose higher value during a market downturn. It’s always advisable to have a
mix of actively-managed funds and index funds in your portfolio.

b. Return factor

Unlike actively-managed funds, Index funds track the performance of the underlying
benchmark in a passive manner. These funds do not aim to beat the benchmark but to just
replicate the performance of the index. However, many a times, the fund returns may not
match that of the index on account of tracking error.

There might be deviations from actual index returns. Before investing in an index fund, you
need to shortlist a fund which has the minimum tracking error. The lower the number of
errors, the better is going to be performance of the fund.

c. Cost of investment

64
Index funds usually have an expense ratio of 0.5% or even less. In comparison, actively-
managed funds have an expense ratio of 1% to 2.5%. The reason being that the portfolio of
the index funds is not passively managed and the fund manager need not formulate any
investment strategy.

The real differentiating factor between two index funds will be their expense ratio. If two
index funds are tracking the Nifty, both of them will deliver largely similar returns. The only
difference will be the expense ratio. The fund having a lower expense ratio will give
marginally higher returns.

d. Investment horizon

Index funds, generally, suits individuals with a long-term investment horizon. Usually, the
fund experiences a lot of fluctuations during the short-run which averages out in the long-run
of, say, more than 7 years in order to give returns in the range of 10%-12%. Those who
choose index funds must be patient enough to stick around for at least that long. Then only,
you as an investor can realise the fund’s full potential.

e. Financial goals

Equity funds can be ideal for achieving long-term financial goals like wealth creation
or retirement planning. Being a high risk-high return haven, these funds are  capable of
generating enough wealth which may help you to retire early and pursue your passion in life.

f. Tax on gains

When you redeem units of index funds, you earn capital gains. The rate of taxation depends
on how long you stayed invested in index funds i.e. the holding period. 

Capital gains you make during the holding period of up to one year are called short-term
capital gains (STCG).

65
CHAPTER V

5. FINDINGS & CONCLUSION:-

Index Funds and ETFs can be said as two sides of a same coin. Still the sides are different in
a coin. It can be concluded that both Index funds and ETFs have its benefits and drawbacks,
but both are handy tools for allowing diversification at low prices. The amount of investment
and the risk appetite of the investor are the aspects to which the investment narrows down
upon, despite being largely similar in characteristics.

There are different and inexperienced investors in the stock market. They are required to
study the aspects before making any choice. A retail investor shall be attracted towards index
funds since they are simpler and cheaper to manage with minimum initial investment options.
Institutional investors can consider ETFs as they offer tax sops and features similar to regular
stocks.

ETFs and open-end index funds are similar in many ways, however they are distinguished in
many aspects. It is pivotal to set the clear goals of investment for effective selection of
suitable investment.

66
For instance, if one requires the flexibility of real-time pricing, or the tax advantage of long-
term shareholding, ETFs could be a good fit. On the other hand, ETFs are more exposed to
market volatility which may be unattractive towards traditional and conservative investor or
if one wants to earn regular income without dealing with short-term fluctuations. Although
some bond-focused ETFs exist, index funds may be better choice if investors are looking for
exposure to illiquid asset classes such as municipal and international bonds. In the end,
personal preference comes down to need for liquidity, the disposable income for investment,
maturity time and preference of asset class.

Choosing between index funds and ETFs is a matter of selecting the appropriate tool for the
job. A regular old hammer might effectively serve your project's needs, whereas a staple gun
might be the better choice. The two tools are similar, but they have subtle yet significant
differences in application and usage.

An investor can wisely use both. You might choose to use an index mutual fund as a core
holding and add ETFs that invest in sectors as satellite holdings to add diversity. Using
investment tools for the appropriate purpose can create a synergistic effect where the whole
portfolio is greater than the sum of its parts.

SUGGESTIONS:-

 In India, although ETFs have been in existence for more than a decade, they are
making their presence felt slowly. The results of the study have important policy
implications for Asset Management Companies (AMCs) as they can position their
products suitably in the market.
 The major reason why ETFs have not caught up asmuch in India as they have in the
United States of America and in Europe is probablybecause of the lesser incentives to
market ETFs as compared to other mutual fundscheme, which earmark higher
amounts for marketing their products.

67
  Moreover, theETFs in India are passively managed. If the ETFs were to be actively
managed (therebygiving higher returns to the investors), ETFs would definitely catch
the attention of theinvesting fraternity.
 Policymakers can come up with better policies to enhance the
growth of ETFs.
 Index funds on the other hand track the market and this strategy is not concerned
with asset selection but only to minimize the cost. ETFs are also similar to this strategy.
However, due to differences in management fees, transaction fees and taxation
efficiency ETFs have lower expense ratios. So, ETFs should have better performance
comparing to index funds.

BIBLIOGRAPHY:-

http://www.nseindia.com

http://www.businessworld.in/index.php/Surveys/Against-All-Indices.html
www.bseindia.com

The information on Exchange Traded Funds and Gold Exchange Traded Funds have been
given in Chapter 5 “EXCHANGE TRADED FUNDS – AN EVALUATION”)
http://www.nseindia.com/research/content/RP_15_Mar2014.pdf
Source: http://www.etfgi.com/index/home (ETFGI).
Source: http://www.ici.org/research/stats/worldwide/ww_12_13 (Investment Company
Institute).
Source: http://portal.amfiindia.com/spages/amdec2013repo.pdf (Association of Mutual Funds
in India).
Source: http://www.morningstar.in/posts/17907/emerging-market-and-asia-ex-japan-funds-
etfscontinue-to-be- big-contributors-of-foreign-inflows.aspx (Morningstar).
Source: http://www.morningstar.in/posts/18766/morningstar-offshore-india-fund-spy-
quarterended-june- 2013.aspx (Morningstar).
Source: http://portal.amfiindia.com/spages/amdec2013repo.pdf.

68
Svetina, M. (2010). Exchange Traded Funds: Performance and competition. Journal of
Applied
Finance, 20(2), 130–145.
Prasanna, K.P. (2012). Performance of Exchange Traded Funds in India. International
Journal of Business and Management, 7, 122–141.
3http://money.outlookindia.com/scripts/IIH021C1.asp?sectionid=2&categoryid=22&articleid
=3142
Source: Nirmal Bang

ANNEXURE:-

Questionnaire – Study on Index Fund and Exchange Traded Funds(ETFs)

Q. Name

Q. Age group

1. Below 20
2. 20-40
3. 40-60
4. Above 60

Q. Profession

1. Student
2. Salaried Employee
3. Daily wage employee

69
 4. Businessmen
5. Retired

Q. Capital invested in market?

1. Below 1 lakh
2. 1-5 lakhs
3. 5-10 lakhs
4. Above 10 lakhs

Q. What kind of investor you think you are?

1. Risk taker
2. Risk Averse
3. Moderate

Q. Rate the importance of liquidity(convertibility to cash) to you

1,2,3,4,5 (1-highest, 5-lowest)

Q. How much volatility(swing in prices) do you prefer in your investment?

1. Low
2. Moderate
3. High

Q. Where did you get to know about ETFs and Index Funds?

1. Friends/Family
2. News/Articles
3. Broker/Adviser/Agent
4. Advertisement
5. Do not know

70
Q. Are ETFs and Index Funds type of Mutual Funds?

1. Yes
2. NO
3. Can’t say

Q. In what proportion do you allocate your funds in ETF/Index fund in your portfolio?

1. 5% and below
2. 10%
3. 15%
4. 20% and above
5. None

Q. According to you which one is easier investment option?

1. Index Funds
2. ETFs

Q. Would you think of buying ETFs/Index funds instead of equity shares?

1. Yes
2. No
3. Maybe

Q. What you think of popularity of ETFs & Index Funds as an investment product?

1. Undervalued
2. Moderate
3. Overvalued

Q. If given a chance to invest, what will be your preference among the two asset classes?

71
1. Index Funds
2. ETF

72