Caution: Risks Attached

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It’s been long since we have recommended a passive fund and with most of the active funds with a good and consistent track record under the equity funds’ category being already recommended, I think this is the right time to come up with a fund like this. But why only ETFs (exchange traded funds) and why this fund? Further, who all should invest in this one? These are some of the questions that one must ask. There has been a long debate in the investment fraternity about which among the passive and active ways of investing is the best. However, there is no definite answer for this, as both have their own pros and cons and are meant for two different genres of investors. However, the pros of passive investing outnumber its cons, except for the performance criteria.

ETFs have lower transaction and management costs as compared to other equity funds. ETFs are more liquid due to real-time buying and selling on the exchanges as well as through the fund. While ETFs replicate the performance of their underlying assets (in this fund’s case, CNX Nifty Junior), its returns will be mostly in line with the underlying assets. However, the difference between the fund’s performance to its benchmark will be on account of the tracking error and funds expenses. One can, however, argue saying that actively managed funds (diversified category) have outperformed the passively managed index funds as well as ETFs in one, three and five-year period by decent margins.
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However, during the bearish phase, ETFs perform better than the active funds as the fall is restricted to the underlying index movement. For instance, in CY08, the NAV of passive funds’ category fell by 51.78 per cent, while the NAV of the diversified funds’ category plunged by 55.37 per cent. Further, ETFs carry lower dependency on the fund manager’s skills and are a good investment vehicle for the investor with conventional mindsets who are against active fund management and also have a trading and a demat account. Investors who want to hedge their active portfolios and can allocate proper time for trading can also invest in this fund or any other ETFs.

Still, before investing, it’s necessary to understand one’s risk appetite and select an ETF considering its underlying index, its cost, tracking error and performance viz-a-viz its underlying index. It’s a mid-cap specific fund that closely tracks or replicates group of stocks represented by the CNX Nifty Junior Index. Thus it falls under higher risk–high return category compared to other large-cap biased index ETFs. The risk-reward matrix is well-explained by the fund’s performance as compared to its category over a period of time.

It was the best performer among the category in CY09 and CY07, beating the category by a massive 4,726 and 2,515 basis points respectively. However, in the tough times of CY08, it underperformed the category by 1,148 basis points. Thus, considering the fund’s performance and its investment style and associated risks, only high risk investors can take limited exposure to this fund.