India joined the club of developed markets by launching Nifty BeES, the first exchange-traded fund (ETF) from Benchmark Asset Management Company (BAMC). The ETF was listed on the capital market segment of the National Stock Exchange on 8 January 2002. Incidentally,with this listing India has become the first emerging economy in Asia to launch an ETF.

Nifty BeES tracks the Standard and Poor (S&P) CNX Nifty Index and hence those invested in all the 50 scrips, which constitute the S&P CNX Nifty Index in the proportion of weightage given to them in the index. The minimum investment for taking the index exposure through Nifty BeES is just one unit (around 1/10th of Nifty).

BAMC made a maiden public issue (closed on 18 December 2001) for Nifty BeES and collected Rs 21 crore. Seven NSE brokers have been designated as authorised participants who, as is the international practice, will perform the role of the market-maker.

Says Benchmark Trustee Company chairman Dr S A Dave: ETFs have the potential of being extremely popular with investors and can reap good volumes. It also provides with an additional instrument of investing, generating higher liquidity and volumes similar to instruments in some advanced countries.

ETFs are the latest and the fastest-growing mutual fund product in the world. There are over 200 ETFs worldwide, consisting of around US$100 billion in assets under management. Over 60 per cent of the volumes of the American Stock Exchange are from ETFs.

BAMC is Indias first and currently the only company to focus exclusively on the passive and quantitative asset management business. In fact, BAMC is the first Asian (except Japan) and just the 18th company worldwide to issue ETFs.

ETFs represent shares of ownership in either fund, unit investment trusts or depository receipts that hold portfolios of common stocks, which closely track the performance and dividend yield of the specific index, either the broad-market sector or international. ETFs give investors the opportunity to buy or sell an entire portfolio of stocks in a single security, as easily as buying or selling a share.

They offer a wide range of investment opportunities. While similar to an index mutual fund, ETFs differ from mutual funds in significant ways. Unlike index mutual funds, ETFs are priced and can be bought and sold throughout the trading day. Furthermore, ETFs can be sold short and bought on margin. It can also be bought or sold through a broker of your choice, just as you buy a stock.

According to brokers, ETFs make it easy for one to buy or sell shares throughout the trading day as against traditional index mutual funds that can generally be purchased or redeemed only at an end-of-day closing price. Moreover, one can purchase as little as one share for most ETFs.

Indexing, often called passive management, involves investing in a group of stocks that represent the composition of the broad-market sector and the international index. Index funds offer market-level performance; they aim to consistently match the market performance of a specific index nothing more, nothing less in advancing or declining markets. Indexed investments may outperform most actively-managed funds over the long term, and generally have lower management and expense fees.

Lets look back at the history of the emergence of such funds. ETFs were created by large investors and institutions in block-sized units of shares (or multiples thereof) known as creation units of a respective ETF. A creation requires a deposit with the trustee of a specified number of shares of a portfolio of stocks, closely approximating the composition of a specific index and cash equal to accumulated dividends. Similarly, block-sized units of ETFs can be redeemed in return for a portfolio of stocks, approximating the index and a specified amount of cash.

Actually the introduction of ETF in India has been hyped for almost two years. The Bombay Stock Exchange in a joint effort with the Unit Trust of India had announced Sensex UTI Notional Depository Receipts (Sunders),thedesiversion of similar globally-known funds like SPDRs, Webs, Diamonds and Cubes that track S&P500, MSCI, Dow Jones and Nasdaq-100 indices respectively. However, due to some reasons, the proposed Sunders did not materialise.

ETFs are passively-managed funds that track a particular index and have the flexibility to trade like a common stock. ETFs combine the attributes of a mutual fund with those of a stock. These are excellent cash products for average investors that offer them an entire range of index stocks as a package, without insisting on large investments.

ETFs also offer hedging and arbitrage opportunities. Investors can go long or short in ETFs to hedge against possible losses in equity exposures. There are also real time arbitrage opportunities between cash, futures and ETF markets. Moreover, ETFs have no compulsory redemption dates, allowing investors to hold on to their positions for as long as they want.

ETF products are different from an index fund in more ways than one. Unlike an index fund, where units are issued in return for cash and redeemed as per the NAV value in just cash, an ETF issues units in lieu of shares and vice versa.

Unlike again an index fund, ETF unit-holders have beneficial rights in the underlying shares that can be redeemed once a week at the NAV-based prices. The only exit route in an index fund is selling at NAV-based prices at the end of a trading session. But ETF unit-holders can exit any time during the day and consequently have access to easy liquidity at the market prices.

The proponents of ETFs are highly confident about getting a broad-spectrum retail participation in ETF from the secondary market. Retail investors are free to trade Sunders throughout the trading session by placing buy-or-sell orders through their brokers, just like any other listed scrip and that too in a Demat form. Thus, the marketable lot is one unit, keeping the fund within the reach of small investors.

Even shares held long-term by institutions can now be converted into ETF units while continuing to hold the beneficial interest in the shares, even as ETF units are freely traded on the bourse. Obviously, this could unlock the huge underlying value in these stocks, a broker said.

There could be a snag in the concept, though. Unlocking the thousands of crores worth of individual corporate stocks that FIs or banks hold in Nifty or the proposed Sensex for Sunders units could immediately make the stockmarket and the Sensex crash.

Any move of this nature could and perhaps would instantly result in a hue and cry within the industry, which still feels secure that a substantial chunk of stocks lie safe with institutions and banks. Moreover, although the safety factor increases several notches, returns from ETFs, or for that matter any mutual fund units, can never be the same as that from an equity, the broker said.