ETF may be a better choice

There are a number of factors that play a crucial role in determining the future performance of a mutual fund scheme, for example - the fund manager’s track record, AMC track record, long-term performance, etc. It takes considerable skills to identify a good fund that may outperform its peers and also the market in the future. Exchange-Traded Funds, on the other hand, track only the Index that it is benchmarking and therefore, there is little scope for outperformance or underperformance. If you aim for market/ Index returns for your investment, the ETFs may be a good choice.

Performance is the focus

The indices, which by their method of construction are based on market capitalization, eliminate or at least, reduce the weight of underperformers in the index portfolio. Therefore, by extension ETFs also eliminate or at least reduce the weight of underperformers in their portfolio.

Unsystematic Risk

Mutual funds are subject to two kinds of risk – Systematic and Unsystematic risks. Systematic risk is unavoidable because equities as an asset class are volatile. Both ETFs and actively managed funds are subject to market risks. Unsystematic risk is a company-specific risk or sector-specific risk. Though mutual funds aim to reduce unsystematic risk by diversifying its portfolio across stocks and sectors, they still have some residual unsystematic risks because actively managed funds may be over-weight on certain stocks and sectors versus the index. Exchange Traded Funds do not have any unsystematic risk because they simply track the index; therefore, it is a good investment option if you want to totally avoid unsystematic risk.

Low cost

The expense ratio of ETFs is much lower than their mutual fund counterparts. The expense ratios of ETFs can be as low as 0.25%, compared to the expense ratio of mutual funds which are usually in the range of 1.5% - 2.25%. Unless the mutual funds generate considerable alpha in the long term, they may not be able to beat the ETF returns in the long term.

Simplicity

ETFs, bring simplicity to your investment compared to actively managed funds. You do not have to analyze past performance or understand the fund manager’s investment style or how the fund has done in up and down markets etc. Most ETFs track the large-cap indices like Nifty, Sensex, BSE – 100, Nifty 100, Nifty Next 50, etc. You can simply select an index and invest in a low-cost ETF, which tracks that index, and your job is done.