New fund option in mid-cap space

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Currently, institutional investors such as the Employees' Provident Fund Organisation (EPFO) and private provident funds are showing keen interest in equity exchange-traded funds (ETFs). Retail investors should, however, weigh the pros and cons of these products before investing.

ICICI Prudential Mutual Fund has launched the ICICI Prudential Midcap Select Exchange Traded Fund (ETF), an open-ended passive fund that will try to provide returns which closely track the S&P BSE Midcap Select Index. This index measures the performance of the 30 largest, most liquid companies within the S&P BSE Midcap Index. ICICI Pru’s ETF will have an expense ratio of 49 basis points. The only other passive funds in the mid-cap space are the Motilal Oswal MOSt Shares 100 ETF and Principal Index Fund-Midcap.

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Liquidity is always a concern for investors betting on the mid-cap category. Especially when the markets are falling sharply, exiting stocks from this category becomes difficult. “By benchmark, the ETF against the Midcap Select Index, which invests in the most liquid midcap stocks, the fund house has taken care of liquidity-related concerns,” says Vishal Dhawan, chief financial planner, Plan Ahead Wealth Advisors.

Investors should note  the BSE Mid-cap Select Index is not a very old index. It came into existence only on June 15, 2015. Only limited data is actual and the rest is back-tested.

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Conservative investors who want to eliminate the risk that arises from wrong stock selection by the fund manager may consider this product. Those interested in placing intra-day bets on the mid-cap index may also look at it (since intra-day quotes are not available in an index fund or an active mutual fund). This product also suits investors keen to have only low-cost products in their investment portfolio.

Most investors in India may, however, prefer to go with active funds in the mid-cap category at this stage. “If you go by historical data, the mid-cap space is one where a significant proportion of active funds have outperformed their benchmarks. Hence, investors should preferably opt for low-cost ETFs in the large-cap space, where outperformance is becoming more difficult, and stick to active funds in the mid-cap space,” says Dhawan.

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One factor hampering the popularity of ETFs among retail investors is their low liquidity (traded volumes) on the stock exchanges. The liquidity problem does not affect institutional investors, who, because of their large holdings, can buy and sell units directly from fund house. But, it is a hurdle for retail investors. “The price at which an ETF trades on a stock exchange can vary widely from its underlying NAV (net asset value) owing to low liquidity and high bid-ask spread. This can impact the returns of retail investors significantly,” says Manoj Nagpal, chief executive officer, Outlook Asia Capital.

Tracking error is another parameter to watch out for when investing in an ETF. It arises due to the ETF's expense ratio, its need to maintain cash holdings, and some inevitable delay in deploying the money received from investors.

Those interested in taking the passive fund route even in the mid-cap space should pause for a while until ICICI Pru’s ETF develops a track record on vital parameters such as tracking error and trading volumes, and only then take a call.

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