Investment Comparison for NRIs : US-listed India ETFs vs MFs in India

NRIs have always wanted to invest a part of their savings in India, be it in real estate or bank deposits. Recently, there has also been an increasing interest amongst NRIs to invest in mutual funds. But many of them fail to consider opportunities to make that same investment through alternatives such as US-listed exchange-traded funds, known as ETFs. US-based India focused ETFs provide the same exposure while benefiting from a lower cost structure, greater liquidity, and a far less onerous paperwork. Below we compare Indian mutual funds to US-based ETFs focused on the Indian market.

Mutual Funds in India

Mutual funds are investment vehicles that pool investor funds in order to make investments. Mutual funds are structured with a specific strategy, such as growth, income, money market, or balanced. To align with their strategy, they invest in equities, bonds, short-term money market instruments, and government securities, or a combination of securities. Mutual funds may also concentrate in specific sectors such as natural resources, financial services, technology; and market capitalization including large cap, medium cap or small-cap investments.

Exchange Traded Funds

ETFs are baskets of securities that mirror an index and trade on an exchange. Like mutual funds, ETFs can be comprised of stocks, bonds or money market instruments. They can have a sector, market capitalization, or geographic focus. An example of an India focused US-based ETF is iShares MSCI India ETF, which mirrors the MSCI India Index, a portfolio of 79 large and medium cap companies representing 85% of the Indian equity market.

Comparison of Mutual Funds vs ETFs

Management

Mutual funds are typically actively invested by a fund manager who is responsible for researching and choosing specific investments in accordance with the fund’s strategy. These holdings may change as the fund manager monitors company, industry and economic developments.

ETFs are typically passively managed. This means their holdings are dictated by whatever index they track. As a passively managed fund, there is no fund manager who must research invest or monitor the underlying investments. Instead, the underlying holdings must be proportional to the index.

A portfolio manager who is actively managing a mutual fund is using research, forecasting, and market expertise in order to perform better than a relevant benchmark index. A passively managed ETF, on the other hand, aims to mirror the returns of an index by investing in an identical portfolio. Research suggests that active funds, on average, underperform their passive counterparts as over the long term it is difficult for portfolio managers to consistently outperform the index.

Pricing

Mutual fund pricing occurs at the end of every day when the Net Asset Value (NAV) is calculated. The NAV is the market value of all fund investments, net of liabilities and expenses, divided by the number of units outstanding. Mutual fund sales and purchases can only be fulfilled at the end of each day, once NAV has been calculated. They cannot be traded intraday.

ETFs have two prices, the market price, and the NAV. The market price is the price at which shares can be bought and sold throughout the day.

Similar to a mutual fund, the NAV is the sum of the market value of the positions held by the ETF, net of liabilities and expenses, divided by the number of units outstanding. NAV and market price are usually similar, with minor differences due to intraday supply and demand.

Trading & Liquidity

Mutual funds do not trade on the market. Instead, they are available via direct or regular plans. With a direct plan, you allocate funds directly to the asset management company managing the mutual fund. With a regular plan, funds are allocated through a broker or distributor who is then paid a commission directly by the asset management company.

ETFs are listed and trade on an exchange so they can be purchased and sold throughout the day through any brokerage firm.

Fees

Mutual funds charge a fee to cover the management and administration costs of the fund. This fee, called an expense ratio, is derived by dividing the total operating costs for the fund by the assets under management. The expense ratio of Indian equity mutual funds average 1% in the case of direct plans and range between 2-2.5% for regular plans.

The expense ratio for ETFs reflect the management and operational costs for the fund. ETFs are passively managed and don’t require active management by a fund manager, resulting in a lower cost structure than mutual funds. According to ETFdb.com, the average expense ratio for the top ten US-listed India ETFs is .80%.

In the chart below, we compare returns for ETFs and mutual funds in light of their varying expense ratios. The US-listed ETFs are the clear winners with a significantly higher return compared to direct or regular plan mutual fund investments.

Account Set-Up

Per SEBI regulations for Indian mutual funds, asset management companies are unable to accept foreign currencies for investment. Prior to investment, NRIs must fulfill KYC requirements and open an NRO or NRE account, allowing them to transfer and convert foreign funds to rupees. In some cases, they may need to present or notarize documents at the nearest Indian Embassy.

As ETFs are exchange-traded, they can be purchased through any brokerage account, including online ones. With the advent of Robo Advisors such as Hemista, the account can be set up in a few minutes. NRIs in the US must fulfill the same KYC requirements, a process that is significantly less time-consuming. As both funds and ETFs are dollar-denominated, funding of the account can quickly be done through an online transfer.

Other Considerations

For Indian mutual funds, stringent reporting requirements under the US Foreign Account Tax Compliance Act (FATCA) has led to limits on which fund houses are willing to take on the risk of NRI money. FATCA requires foreign financial institutions and other entities to disclose any foreign assets held by a U.S. resident for tax purposes, including H1B visa holders, US permanent residents, and citizens. Given the high cost of compliance with these requirements, only the larger mutual fund companies are willing to take NRI funds.

Conclusion

NRIs looking to gain exposure to the Indian equities market should consider US-listed India ETFs. With their lower cost structure, greater liquidity and less cumbersome compliance requirements, ETFs are a better option than Indian mutual funds for investment in the Indian market.

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