State drives ETF growth in India

Growth in the exchange-traded fund industry in India is likely to accelerate on the back of government plans to launch an ETF and introduce regulatory changes.

Last month, I visited India as a keynote speaker at Motilal Oswal Asset Management’s annual ETF conference in Mumbai. At the time of my last trip to the country in 2009, there were 18 ETFs with assets of $500 million. In the past four years, the assets have increased by 300% to $2 billion, the number of products has more than doubled to 37 and there are now 15 providers with listings on two exchanges.

However, ETFs are still a relatively new product in India and the first ETF – the Goldman Sachs Nifty BeES – launched only in 2002. Although there has been significant growth, ETFs account for only 2% of the assets in Indian mutual funds.

The government is putting its weight behind the industry with several initiatives, starting with plans to create an ETF and introducing incentive schemes to attract retail investors. It is also applying rules similar to the UK’s Retail Distribution Review and lowering transaction costs on ETFs while changing regulations to allow institutional investors, such as insurance companies and mutual funds, to invest in ETFs.

The proposed new ETF is set to launch this year and will be based on shares of listed central public-sector enterprises. The government has appointed ICICI Securities as an adviser, India Index Services & Products as the index provider and Goldman Sachs Asset Management as the asset manager and provider of the CPSE ETF.

The ETF will be designed to track a benchmark which is being created from a selection of the 50 public-sector bodies listed on stock exchanges in India. These businesses account for about 17% of the market cap but it is expected that only public enterprises that are liquid and where the government owns more than 50% will be considered for the benchmark. Public-sector banks will not be included.

The government wants the ETF to be attractive to both retail and institutional investors as it offers diversification and reduces concentration risk. It is expected that the CPSE ETF will be launched as a new fund followed by further tranches providing loyalty discounts. In June, the securities transaction tax on ETFs and mutual funds was reduced from 0.25% to 0.001%.

The country’s Ministry of Finance has announced that it is working with domestic regulators to allow insurance companies and mutual funds to invest in the ETF, which will open a new pool of assets to the product.

Retail use of ETFs has been growing since the introduction of RDR-like regulatory changes that ban the payment of distribution fees to financial advisers selling financial products and require greater transparency on fees. Foreign investment by retail investors is typically restricted to $200,000 per year but ETFs listed in India tracking the Nasdaq 100 and Hang Seng index are making it easier for individuals to get exposure outside India and benefit from diversification.

The government is also working to make it easier for foreign institutional investors to invest directly in shares listed in India. Due to a lengthy and cumbersome approval process, many foreign investors use ETFs listed on foreign exchanges to gain exposure to India. At the end of June, there were 36 ETFs listed outside India providing exposure to the country or its currency with assets of $5.14 billion from 23 providers on 20 exchanges. The assets in the top three foreign ETFs amount to $2.58 billion – larger than the ETF industry in India.

http://www.efinancialnews.com/story/2013-08-19/state-drives-etf-growth-in-india-comment