ION’s Sandeep Sabnani and DSP’s Anil Ghelani discuss the rise of ETFs in India

Key Takeaways

• ETF growth helped by their simplicity, low cost, government initiatives

• Asset management challenges include competition with active strategies

• ETF landscape is expected to diversify and grow further

The rise of passive investment strategies, and Exchange-Traded Funds (ETFs) in particular, has been a significant development in India’s financial markets. Indeed, as we wrote earlier this year, the country has been at the forefront of this trend globally, leading it to dethrone Hong Kong as the world’s fourth biggest stock market.

What are the factors driving this growth, the challenges faced by asset managers, the role of brokers, and the broader perspectives on the ETF landscape in India?

The insights are drawn from an ION Markets ConversatION Podcast featuring Sandeep Sabnani, head of equities product strategy and growth at ION Markets, and Anil Ghelani from India-based DSP Investment Managers, where he looks after ETFs and passive investments.

Growth drivers

ETFs have gained popularity in India due to their unique blend of simplicity and cost-effectiveness. Anil Ghelani highlighted several key reasons for this growth. He explains that ETFs offer a straightforward investment solution that is easy to understand and comes with low costs, making them attractive to both individual and institutional investors.

Additionally, the Indian government has utilized ETFs for disinvestment purposes, enhancing awareness and acceptability of ETFs in the market. He also notes that actively managed funds have struggled to consistently outperform benchmarks, leading investors to prefer the low-cost, passive nature of ETFs.

There has been “phenomenal growth” and where 10 years ago the “total size of such passive funds was about 3 to 4 percent of the industry. We have now increased to about 17 to 18 percent of the total Indian asset management industry.”

Sandeep Sabnani emphasized that India’s price-conscious market makes ETFs a ‘perfect fit, especially for retail investors. “ETFs provide diversified exposure to various sectors, which make them an even more attractive choice for the Indian investor,” he said. “So be it institutional or retail, they give everyone an opportunity to be a part of India’s growth story.”

Challenges for asset managers

The growth of ETFs poses several challenges for asset managers. One significant challenge is the competition with active management. As ETFs gain popularity, there is increased scrutiny on the performance of actively managed funds. Asset managers need to adapt by positioning both active and passive strategies as complementary rather than competing.

“If we take a hint from what has happened in some of the global markets, let’s say in the US market, after about one decade where passive funds saw higher inflows as compared to active,” Ghelani said. “At end of the 2023 data, passive funds have in fact outpaced and the total size is higher than the total size of active funds.”

When that change happens in India asset managers must be able to align their thinking, their business model, their outreach to clients in a suitable way. Advisors and investors should know ‘how they can use both active and passive as a complementary strategy rather than competing strategy. “This can result in a net/net win/win solution for the client as well as for the asset managers,” Ghelani said.

Role of brokers

Brokers play a vital role in the ETF ecosystem by ensuring smooth execution of trades and rebalancing of ETF portfolios. For Ghelani, “The brokers have a great way of executing trades, giving fills so that we are able to track our portfolio in a very smooth way.”

The role of brokers in providing market-making services is crucial. Increased market-making activities can enhance liquidity and reduce costs for investors.

For Sabnani, brokers need to be agile and responsive to the needs of asset managers. Theys must be able to understand and manage the baskets that the asset managers are asking them to execute.

“What this means is providing them with access to various trading platforms, ensuring the ETFs are distributed widely to both institutional and retail investors,” he said. “In addition, brokers must also be able to provide state-of-the-art tools such as algos and also ensure regulatory compliance in a complex market such as India.”

Regulatory environment and future developments

India’s regulatory environment has been supportive of ETF growth. The Securities and Exchange Board of India (SEBI) has implemented measures to reduce transaction costs and simplify the process for launching new ETFs. It has also promoted investor education and awareness, further driving ETF adoption.

“Indian regulators have relaxed guidelines to encourage the development of passive investment vehicles such as the ETFs, Sabani said.

Looking ahead, the ETF landscape in India is expected to evolve with continued regulatory support to balance active and passive investments. There will be an increasingly diverse range of ETFs, including thematic and multi-asset class ETFs.

“We are very hopeful that very soon it will get permissible to launch hybrid, multi-asset class ETFs,” Ghelani said.

The potential impacts of changes to capital gains taxes on ETF adoption will also be an area to watch.

The rise of ETFs in India reflects a broader trend towards passive investment strategies. With continued regulatory support, increasing investor awareness, and the evolving role of brokers, ETFs are poised to play a significant role in India’s financial markets. Asset managers who can effectively integrate both active and passive strategies will be well-positioned to navigate this dynamic landscape.