Index ETFs fail to follow indices as market makers stay on the sidelines

Bombay: As the Nifty slumped 7.61% on March 16, exchange-traded funds (ETFs) following it failed to keep up. Nippon India ETF Nifty BEES, one of the largest and oldest tracking ETFs, fell just 2.23%. SBI ETF Nifty 50, which manages assets of ??64,464 crore, and is India’s largest equity mutual fund program, closed instead of down. It closed with a gain of 1.16%. The follow-up failure was not just limited to the Nifty. The SBI Sensex ETF lost 3.61%, even as the Sensex itself fell 7.96%. Intra-day ETF movements following Indian benchmarks were also very out of sync with the underlying indices. This may have hurt retail investors trying to profit from the market correction.

An ETF is a passive mutual fund. Its objective is to simply give the same returns as the index it tracks, such as Sensex or Nifty. It does not seek to outperform and therefore has a low expense ratio. A fund manager at one of India’s largest ETF providers told Mint on condition of anonymity that there were three reasons why ETFs failed to track benchmarks. First, he said market makers were facing liquidity issues in their other positions in a volatile market. Market makers (usually brokers) are entities that buy and sell shares of ETFs, making money by charging a small spread between their buy and sell prices. Their activity ensures that the price of an ETF trades close to its net asset value (NAV). Second, he said the government’s foreclosure on Yes Bank shares turned market makers off. Yes, Bank only occupies a 0.2% weight in Nifty, but that is enough to erase the low margins on which market makers operate. Third, there was concern that the circuit limits would be triggered due to heavy drops and therefore that the exchanges would be interrupted. Circuit limits are percentage limits set by exchanges to suspend trading in the event of steep drops.

Anubhav Srivastava, Partner and Fund Manager, Infinity Alternatives noted that ETFs are traded at a premium rather than a discount to indices. “There could be several explanations. As market makers were not active, retail investors could have pushed up the price. Alternatively, it could be a market player who wants a high last traded price to make their books look good, ”he said.

The ETF’s desynchronized behavior is said to have affected both retail investors buying directly and those buying baskets of ETFs through platforms, a concept popularized by fintech companies such as Smallcase. “People who invest in thematic ETF baskets may not even have realized what happened. The net asset value of the basket is one step away from the underlying ETFs and many investors would not have verified the underlying, ”said Gaurav Rastogi, CEO of Kuvera, a mutual fund investment platform. retail investors, the lesson seems to be: buy index funds Index funds are bought and sold at their net asset value (NAV) from a fund house and, therefore, the danger of buying the fund with a high premium is excluded.

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