Quarterly review – what’s new in Prime ETFs, our ETF recommendations

Prime ETFs is the list of our ETF recommendations. This ETF list features both broad-market and thematic indices. And so far, we haven’t written much on Prime ETFs, unlike Prime Funds, so many of you tend to miss this list . So in this review season, we’ve decided to bring Prime ETFs into the limelight a bit.

First, a quick note on how we draw up the ETF recommendations list. We haven’t yet come up with ETF ratings, as we have with funds, but we do plan to add ETFs to our rating list later down the line. But when we analyse ETFs, we use the following factors:

• Quantitative metrics, where trading volumes take the top spot. Other metrics we look at are tracking error against the benchmark in different time periods, expense ratio and differentials between the ETF’s market price and its NAV, among others.
• Index performance, by which we mean that the index needs to deliver better than the basic Nifty 100 or the Nifty 500 or at least beat these indices on some factors, such as downside containment. If this is not so, then an investor is better off simply holding the Nifty 100. So though an index may sound particularly interesting, it may not always be worth investing in.
• Index construct, which is the methodology used to build the index. If the methodology used to build the index does not seem fitting, we may ignore it even if performance is sound. For example, the Value index has performed very well, but the factors it is built on throws up more ‘quality’ companies than value. This, and the earlier point, are more qualitative aspects other than simple quantitative metrics that we use.

The above explains the metrics we use to arrive at the ETF recommendations list. With Prime ETFs list itself, we aim to do the following:

• Give a blend – if there’s one thing we say time and again, it is that your portfolio needs a mix of different types of funds to properly diversify and spread your risks. To that end, in the ETFs, we look to provide ETFs across market capitalisations, and those that offer differentiation such as thematic, factor-based or other indices. We may have more than one ETF representing a particular index. The aim here is to offer some variety to those looking for it, since some of you do not want to hold many ETFs from the same AMC.
• Usable by any investor – if you’re a firm believer in passive investing, the different indices will allow you to easily build a diversified portfolio that captures different opportunities. You can draw cues from our passive Prime portfolios. And if you’re not a passive-only investor, some of the indices will still be good add-ons to your portfolio which are not available in the mutual fund space.
• Balance attractiveness and volumes – good trading volumes are the single most important criteria in an ETF, since it keeps tracking errors in check. However, there are ETFs built on good, promising indices, but which do not have high volumes. In such cases, if the tracking error in different time-frames is in line with more liquid ETFs, we still include it in our ETF recommendations list. If we were to be very rigid on the volume aspect in an ETF market where the number of takers in general are low, we’d wind up needlessly missing opportunities. In such cases, we make the assumption that a retail investor may not invest several lakhs or crores in one shot. We sound off on low volumes where this holds (in the Alerts column), and in such ETFs, you can accumulate (or exit) gradually in phases. 

We hope this gives you an understanding of how we draw up the ETF recommendations list and how you can use it. Like we do with Prime Funds, each Prime ETF has a ‘Why this ETF’ with which you can understand how to use the ETF. Now, on to the changes in this quarter.

Changes in ETF recommendations

We have only added ETFs in this quarter. In any case, removing an ETF will be far less frequent than in mutual funds as  an index underperforming is simply a factor of the market and the nature of that index. Unless we think that the index’s construct will no longer help it deliver or where we think there is a better index derived from a parent index that can effectively replace the parent index itself, we will continue to maintain it in the list.

We have made no changes in the Moderate risk and High risk ETF sets. The ETFs here continue to hold as they have been so far. ICICI Pru Nifty 100 ETF and ICICI Pru BSE 500 ETF still have low volumes, but these have improved from a quarter ago. Their tracking error is low for the most part, but there can be a few days with spikes in differentials between market price and NAV. This generally tends to happen when there’s a sudden jump in volumes. Accumulating slowly here, and maintaining lower exposure to these ETFs can help overcome these problems until they iron out.

ETFs – themes & strategies

In this set, we have added three ETFs. The first is Kotak Banking ETF. This ETF is in addition to Nippon Bank Bees that we already have in the list. The ETF is built on the Nifty Bank index, which houses the largest and most liquid bank stocks (both private and public sector banks). Of course, this also means that the index is dominated by a few stocks. Banking as a sector, though, is a play on the economy itself and is the single largest sector in terms of market representation.

Kotak Banking ETF provides an alternative in a space largely dominated by the Nippon house. The Kotak ETF scores more or less exactly as the Nippon ETF on tracking error in short-term and long-term periods, and average expense ratios. While trading volumes are obviously extremely high for the Nippon ETF, Kotak Banking ETF still scores well on volumes as well. Average daily traded value in the past three months stood at about Rs 7.7 crore for the ETF, which is a number above almost all ETFs, sector or broad-market.

For the same reason of provided more options, we added HDFC Gold ETF to our existing recommendation of Nippon Gold Bees. Trading volumes for this ETF is better than most other ETFs, barring, of course, Nippon India ETF and SBI Gold ETF. However, HDFC Gold fares better than the SBI ETF on tracking error despite being slightly higher on expense ratio. Please note that we feature gold ETFs in our Prime ETF list if you wish to diversify into gold. It is not a ‘timing’ on gold.

The final ETF we’ve added is Bharat Bond ETF April 2030, a debt index ETF. The launch of the Bharat Bond ETFs now allow an asset-allocated portfolio to be built using ETFs alone. The Bharat Bond’s low expense ratio props up returns, especially when compared to debt funds. We have gone with the 2030 maturity ETF as it fits a long-term portfolio. For lower time frames, we think active debt funds are better faced to nimbly manage duration within their mandated range.

You should hold the Bharat Bond 2030 ETF until maturity, if you do not track the debt market. Otherwise, you can book profits/exit it it in the interim if you see high returns – since the next ten years can give enough scope for other yield rallies. Do note that the ETF will be volatile as price changes based on rate cycle; volatility will reduce closer to maturity.

The table below summarises the changes in our ETF recommendations in this review.

To get the full list of Prime ETFs, go here. You can also read our article on whether to go for ETFs or index funds here.