ETFs vs Large Cap Funds

Comparison of performance of ETFs and Large cap funds in 2020

Introduction

Exchange traded funds (ETFs) having the Nifty 50 and the S&P BSE Sensex as underlying indices have outperformed the large-cap funds according to the data from the Association of Mutual Funds in India (AMFI). Here are the key reasons behind the out-performance of ETFs/Index Funds over a number of Actively Managed Large Cap Funds.

ETFs vs Large Cap Funds

Out-performance of ETFs

• ETFs Bench-marked to Nifty 50 & BSE Sensex have delivered an average return of 71.69% from March-lows (i.e. March 23, 2020), while large cap funds have managed to furnished 64.04% returns. That is an out-performance  of 7.63% by the ETFs.
• Even when we consider the 1 year returns (2019-20), ETFs and Large Cap funds stand at 10.57% and 8.47%, respectively. Hence, ETFs have once again outperformed the Large Cap funds by 2.1%.
• ETFs have higher AUMs as compared to actively managed large cap funds as there is an indirect flow from various sources like EPFO , etc which is directed in ETFs

Assets Under Management (AUM) of Top ETFs bench-marked to NIFTY 50 & Sensex

Why NIFTY 50 & Sensex ETFs could outperform Large Cap Funds ?

1. Rising Weights of a Handful of Stocks in Benchmark Indices

• Smaller number of stocks constitute higher weights in NIFTY 50 & Sensex.  For Example : There has been a significant rise in weightage of Reliance Industries in NIFTY 50 from 10% in March-lows (i.e. March 23, 2020) to 13.2% in October 2020.

• While active mutual fund managers have to at all times adhere to the regulations, they are restricted and cannot exceed the weight of any stock in the portfolio beyond the Regulatory threshold of 10% of Portfolio Size as it leads to concentration and defeats the purpose of diversification.

• The consistent gain in the share prices of a stocks lead to an increase in the weight of that stock in the Index and active mutual funds were unable to track the stock’s movement effectively.

• On the other hand, ETFs face no such restrictions and hence are more efficient since their underlying is the index itself.

• ETFs have no such binding and passively follow the index weightage precisely. Therefore ETFs have been riding the purple patch as the NIFTY 50 and Sensex indices zoomed in the previous months, mirroring their returns.

The top 5 companies account for a cumulative weightage of 42.66% and the top 10 companies account for 61.82%. There has been a rise in weightages of Banking & NBFC Stocks due to 15-20% rally in November.

2. Higher expense Ratio of Large Cap Funds vs Index Funds

• Higher Expense Ratios (i.e. 1.7%-2.3%) has pulled down the return of large-cap funds.

• While ETFs typically exhibit an expense ratio one-fifth the of large-cap funds. This has also played a critical role, thereby helping ETFs to outperform the Large Cap funds.