Quarterly Review – What’s in and what’s out in Prime ETFs?

We have made our quarterly review and changes to our list of recommended ETFs – Prime ETFs. Before we move to the changes, a brief note on how we pick our ETFs. 

We start with comparing indices on which ETFs are built. We look at them from their ability to consistently deliver, contain downsides and beat peers and even active funds. Not every index is a good one to pick. For example, an index derived from, say, the Nifty 50 or Nifty 100 may not beat the parent nor contain downside better. In such cases, there will be little reason to consider it unless the theme has some objective to it. 

In other cases, we may reject a good performing index if we feel it is not optimally constructed for its objective, and there could be other ways to play the index. We have provided some examples further down in this report on why we did not consider some indices despite returns. 

Once the indices are filtered, we look at the ETFs that mirror these indices, comparing expense ratios, tracking error, corpus and, most importantly, turnover traded. We try to look for those that are optimal for a retail investor across these metrics. 

Those ETFs less than a year old are not included (unless they make for a compelling case) as we prefer to see how volume builds up and how tracking error moves. Low volume is not necessarily a no if the traded volume is consistent across several months. In such cases we do sound you off on the low quantum traded, which is why you will see that we have sometimes asked you to accumulate over the course of several days. 

Now, for the changes made this quarter and the rationale. You can access the full Prime ETFs list here.

Moderate risk

This ETF set houses indices that are large-cap oriented. This quarter, changes we made are below.

Name of ETF	Action	Comment
SBI ETF Nifty 50	Added to recommendation	Good for a passive large-cap exposure, and can pair with any other ETF or equity fund
ICICI Pru Nifty Low Vol 30 ETF	Moved from ‘Themes & Strategies’ to ‘Moderate risk’	Moved categories to ensure that those looking for lower-risk equity indices do not inadvertently miss out

Rationale for changes

We added the SBI ETF Nifty 50, which tracks the main Nifty 50 index. We’ve added this ETF to provide more options for the Nifty 50, which is among the most widely tracked Indian indices. Rising AUM, a low expense ratio, and very low tracking error set this ETF apart from the several others tracking the Nifty 50. On trading volumes, though, Nippon India ETF, which we also feature in our recommended list, fares better. 

Then, we moved ICICI Pru Nifty Low Vol 30 ETF to this category. earlier, we had listed it under the ‘Themes & Strategies’ category as the ETF was built on a strategy-based index. The index – Nifty 100 Low Vol 30 – holds 30 stocks chosen from the Nifty 100 basket. The index picks stocks with low return deviation and is weighted based on their volatility score. We listed this ETF in the ‘Strategies’ section but have moved it here as it is a lower-volatile moderate-risk option that can be used in long-term portfolios which investors may otherwise miss.

This index is useful as a hedge in long-term portfolios, being less volatile than the Nifty 100 or the Nifty 50. The Nifty Low Vol index falls much lesser than these two indices too; it captured just 68% of the Nifty 100’s loss on a 1-year basis over the past 4-year period. Over the past decade, during loss-making years, the average 1-year loss it delivered was 6.2% against the 9.4% of the Nifty 100 TRI. However, on market upsides, the index tends to lag behind. 

Keeping exposure limited to about 10% of the portfolio will help contain downsides without jeopardising participation in rising markets. Note that the ETF’s volumes are not very strong, and investing across several days will be necessary.

High risk

This ETF set houses indices that are typically volatile but can deliver well on upsides. This quarter, changes we made are below.

Name of ETF	Action	Comment
ICICI Prudential S&P BSE 500 ETF	Added to recommendation	Useful as a proxy for the entire listed space
ICICI Prudential Midcap Select ETF	Removed from recommendation	Switch investments to Nifty Midcap 150 index ETF.

Rationale for changes

We added ICICI Pru S&P BSE 500 ETF, which tracks the BSE 500 index. This ETF does not have very high volumes. It is reasonable enough with an average daily turnover of Rs 63 lakh over the past 3 months, though volumes have dipped as low as Rs 1.3 lakh. Stagger investments over several days. Despite lower volumes, the index’s tracking error is contained.

The BSE 500 index houses the top 500 stocks – and this represents over 95% of the listed universe. In effect, owning this index is similar to owning the entire market. It provides exposure to large-cap, mid-cap and even small-cap stocks at one shot and sidesteps the need to change allocations to each market-cap segment. The index is less volatile than the mid-cap indices, and can be a lower-risk route to owning mid-caps/small-caps than a dedicated index. The BSE 500 delivered an annualised average 3-year return of 12% over the past decade, against the Nifty Midcap 100’s 13.7%. 

The index is useful to quickly snap up buying opportunities when the markets correct quickly and swiftly, as we’re seeing now. Small allocations to this index in a long-term portfolio is also useful to counter active multi-cap funds.

We removed ICICI Pru Select Midcap owning to the index not satisfying the reasons we had for including it. The BSE Select Midcap lists the 30 larger and more liquid mid-cap companies in the BSE Midcap index, and was therefore a lower-risk alternative to a volatile and highly risky space. However, the index in this correction has fallen severely behind even the Nifty Midcap 150, which is among the riskier mid-cap options. You can switch instead to the Nifty Midcap 150 (Nippon India ETF Midcap 150).

Themes & Strategies

This ETF set houses indices that are either sector-based, or built on different themes. This quarter, changes we made are below.

Name of ETF	Action	Comment
Nippon India ETF Gold BeES	Added to recommendation	Useful for those who want to invest in gold

Rationale for changes

We added Nippon India ETF Gold BeES, which invests in gold and tracks domestic gold prices. While options to invest in gold are covered separately in Theme Parks and in our weekly investment calls, we have included it in Prime ETFs for better reference. Do note that this is not a call that we are making on gold at this time. 

Gold is useful as a portfolio hedge when equity markets – especially global equity markets – are correcting and are in a risk-off mode. But for the same reason, gold can through long periods of flat to poor returns, when equities are going strong. Therefore, keeping exposure to about 10-15% of the portfolio will be helpful in containing downsides without curtailing returns. 

Nippon India ETF Gold BeEs is among the foremost gold ETFs and has the highest trading volumes, along with a low expense ratio and low tracking error.

Why some indices did not make it to Prime ETFs

One of the top performing indices was the Nifty Private Banking TRI. It beat the Nifty 500 TRI a whopping 99% of the times when 3-year returns were rolled daily for over 10 years. It also has a good ETF to ride it (ICICI Pru Private Banks ETF).

However, a closer look at the index suggests that just 3 stocks HDFC Bank, ICICI Bank, Kotak Mahindra Bank accounted for 68% of the index. This is almost the same as the Nifty Bank index. The other stocks such as IndusInd Bank or Bandhan Bank are not the most favoured by the market at this juncture. 

For those who want just the large private banks, we think simply owning the large ones directly would make for a better option right now. Else, the Bank Nifty may provide slightly higher diversification, with a few large PSU banks.

Another index that entered our radar was the NV 50 Value 20 index. This index did a decent job of beating its parent the Nifty 50 although we found that the Nifty 100 Low Volatility 30 does a better job over 3-year periods, in the large cap category.

NV 50 Value 20 index also had a limitation of picking value from a narrow index – the Nifty 50 – using metrics such as return on capital employed, price to earnings, price to book value and dividend yield ratios. With a limited universe to choose from, the index had top holdings in HUL, TCS and Infosys, which are not particularly value even though they score well on return on capital and dividend yield metrics. A wider universe would perhaps fulfil the real objective of value. 

A third index, Nifty 100 Quality 30, surprisingly, did not convincingly beat its parent in the way you would expect ‘quality stocks’ to. Barring recent slim outperformance, it in fact underperformed the Nifty 100 TRI when returns were rolled for 3-year periods over the last 6 years. Here again, consumer and IT stocks, unsurprisingly, accounted for two-thirds of the portfolio. We think the Low Volatility index offers similar top stocks and sectors (more diversified) and performs far better. 

Click here to see the full list of Prime ETFs.