With just three initial public offerings (IPOs) in 2020, the stock market has a vast appetite for new products.

Despite 500 listed stocks, long-term value investors, who are flush with liquidity, are forced to chase only a few blue-chip companies with a history of sound and sustained growth and regular dividend distribution.

It was against this background that two exchange-traded funds (ETFs) were launched last week. Many people argue that awareness about ETFs among ordinary investors should have been created before their launch. “Roadshows should have been conducted. The product should have been promoted more aggressively, explaining its features to the local novice investors given to a single ready market,” complained a veteran at the Pakistan Stock Exchange (PSX).

A person associated closely with the regulators said roadshows would be held and knowledge about the product would be disseminated in the general public starting next week.

“That will be like putting the cart before the horse,” growled an investor who was fumbling with extensively distributed literature on the product.

But for all that, it still is a relief to see a new product in the capital market that should provide it with the much-needed depth. The global ETF market size stands at a colossal $7 trillion. Although a new concept in Pakistan, ETFs have more money under management in most advanced markets than all mutual funds combined.

Exchange-traded funds combine the returns of equity investing with the diversity offered by mutual funds

The PSX has four ETFs namely NIT Pakistan Gateway ETF, UBL Pakistan Enterprise ETF, Meezan Pakistan ETF and NBP Pakistan Growth ETF.

ETFs are an investment product, which combines the returns offered by the stock market with the diversity provided by a mutual fund. The CEO of Al Meezan Investment Management Ltd, Mohammad Shoaib, told this writer that ETFs were cost effective and provided diversified investment opportunities to investors. The ETF his company has launched is a basket of 12 stocks: Lucky Cement, Pakistan Petroleum, DG Khan Cement, Maple Leaf Cement, OGDC, PSO, Searle Pakistan, Hascol Petroleum, Engro Corporation, Sui Northern Gas Pipelines, Engro Fertiliser and Pakistan Oilfields. Mr Shoaib said the basket was representative of a wide spectrum of sectors, including fertiliser, oil, construction and pharmaceutical.

The ETFs are cost effective in the sense that their management fees would be charged at 0.5 per cent against the 2pc charged by mutual funds. The obvious advantage to the investor is that they can purchase a basket of shares representing different sectors and with the scrips of their choice. As the market for ETFs grows and expands, the choice for ETFs combining desirable scrips will widen.

NBP Pakistan Growth ETF, for instance, is investing in a basket of 15 blue-chip companies from six sectors.

Mr Shoaib of Al Meezan said the reason for the rapid global growth of the ETF market was perhaps the investors’ discretion and power to invest in stocks of their liking unlike in mutual funds where the fund manager has the authority to put the unitholders’ money according to their own wisdom. Also, customers of a regular mutual fund deal directly with the fund for the purchase and redemption of units and the ETFs trade like stocks.

Besides, mutual funds calculate and provide their prices once in a day after the market close while the value of ETFs is available on an intra-day basis. This gives the investor the opportunity to purchase or sell the ETF during the trading time.

Another fund manager who also heads one of the four ETFs said: “ETFs are not typically actively managed and are based on a passive strategy.” He affirmed that ETFs started growing rapidly in India when provident funds started contributing to them. “There was a regulatory provision, which encouraged retirement funds to invest in ETFs,” he said.

But ETFs are not altogether free of disadvantages. The two mentionable disadvantages are that ETFs track an index offering a passive strategy. “These particular types do not actively try and beat the market. With managed funds, you can select different strategies,” said an analyst. Secondly, trading volumes in ETFs may be low. So there may be a wide bid-ask spread between the intra-day net asset value and the market price.

Currently, JS Global is the only market-maker for ETFs. Since market-makers provide the essential service of ensuring liquidity for the investment product, they need financial muscle and access to technology, which are currently scarce. More market-makers may enter the field going forward.

Securities and Exchange Commission of Pakistan (SECP) Chairman Aamir Khan said he had big plans for the product. “The SECP is determined to create more competitive playing field for ETFs,” he vowed. He promised to address tax disparities, achieving tax credit and allowing investments in ETFs though special convertible rupee accounts.

Mr Khan observed that the regulator was taking measures to increase awareness and expand outreach of ETFs to make them available on not just the ready counter but others as well, including futures, margin trading system etc. The SECP chairman also announced at the gong ceremony that another set of ETFs was in the approval process.

So would the ETFs compete with mutual funds or equities? When the question was put to a fund manager, he responded that the competition would probably be with mutual funds. But as the product would attract more liquidity, all three investment instruments — equities, mutual funds and ETFs — would be better off.

Another fund manager said that as per SECP regulations, ETFs were open-end mutual funds. He reckoned that comparing open-end mutual funds and ETFs was unnecessary since the latter were a lot like regular mutual funds. “ETFs differ from regular mutual funds in the way they are priced and in the way they trade. When you buy one unit of an ETF, it represents a proportionate share of the fund’s underlying net assets. He said the objective of ETFs was to mimic the performance of the underlying index and minimise the tracking error.

Published in Dawn, The Business and Finance Weekly, October 12th, 2020

Opinion

Casualties of war
17 Sep 2021

Casualties of war

As we ruminate over the consequences of America making a mockery of international law, it is equally important to take an inward
Love of wealth
17 Sep 2021

Love of wealth

Those obsessed with wealth are likely to be involved in corrupt practices.
Pro-rich growth
Updated 17 Sep 2021

Pro-rich growth

An intellectually honest prognosis of our political economy for the working class makes for grim reading.

Editorial

TTP amnesty?
Updated 17 Sep 2021

TTP amnesty?

An amnesty should be for some individuals, not the entire outfit.
17 Sep 2021

Media regulation

THE needless controversy over media regulation may finally be heading for a resolution. In a meeting with ...
17 Sep 2021

Refusing audit

THE continuous resistance put up by several public-sector organisations to submitting their accounts for audit by ...
Aid for Afghans
16 Sep 2021

Aid for Afghans

Humanitarian aid can resume even if the world decides to hold back on formal recognition of the regime for now.
16 Sep 2021

Wheat price

THE government’s decision to raise the wheat release price, or the rate at which provinces issue their grain ...
16 Sep 2021

Keeping the press out

ON Monday, the government yet again displayed its rising contempt for the freedom of press — this time in...