Nifty BeES vs Index Funds–Analysis (including brokerage costs)

Nifty BeES was the first ETF (Exchange Traded Fund) in India. The investment objective of Nifty BeES is to provide investment returns that, before expenses, closely correspond to the total returns of securities as represented by the S&P CNX Nifty Index. Some of the features of Nifty BeES are –

a) One unit of Nifty BeES is approximately 1/10th of the S&P CNX Nifty Index

b) Nifty BeES is listed and traded on the NSE-Capital market segment and is settled in the rolling segment on T+2 basis

c) Nifty BeES can be settled only in electronic (demat) form.

For the ETF uninitiated, here is a brief note on Mutual Funds vs ETFs – http://getahead.rediff.com/slide-show/2010/mar/06/slide-show-1-money-mutual-funds-versus-exchange-traded-funds-what-should-you-choose.htm

Here is a note on Nifty BeES itself – http://www.masterandstudent.com/2008/10/what-is-nifty-bees-etf.html

The objective of this blogpost is to compare returns of Nifty BeES vs Index funds. Index funds can be based on Sensex or Nifty. For the purpose of this blogpost, Index funds mean Index funds based on Nifty.

About a year ago, I researched on the Internet quite extensively on the returns of SIPing in Nifty BeES versus Index funds. Conceptually, both are one and the same – that is, they invest in Nifty, which consist of the same set of 50 stocks. Ergo, the returns also have to be very similar, if not the same.

I was wrong.

Before I delve further, let me briefly introduce the concepts of Expense Ratio and Tracking Error.

Expense Ratio: Simply put, expense ratio is the cost associated with running a particular fund. It includes the management fee and operating expenses like the registrar and transfer agent fee, audit fee, custodian fee, marketing and distribution fee.  Usually, this cost is annualized and you would notice ‘Expense Ratio’ column somewhere way below in the Offer document. The NAV of each of the funds that we see in newspapers is after deducting this expense. Usually, expense ratios of equity funds are greater than debt funds.

Tracking Error: Simply put, Tracking error is the standard deviation of the returns differential between the fund and its benchmark. A fund that has a high tracking error is not expected to follow the benchmark closely and thereby might result in lower returns than the benchmark.

Coming back to our Nifty BeES vs Index funds argument, I present to you a table compiled by Ajay Shah (wonderful blog – must follow!) sometime back (slightly dated, July 2008. One Mint also compiled this data as recent as May 2010 and I don’t see much difference, do you?) –

 

Scheme	Tracking error (%)	Expenses (%)
Nifty BeES	0.19	0.5
Franklin India Index Fund – NSE Nifty Plan – Growth	0.42	1
Franklin India Index Tax Fund	0.58	1.5
UTI SUNDER	0.59	0.5
Tata Index Fund – Nifty Plan – Option A	0.63	1.5
UTI Nifty Fund – Growth	0.7	1.21
PRINCIPAL Index Fund – Growth	0.86	0.75
ICICI Prudential Index Fund	1.1	1.25
SBI Magnum Index Fund – Growth	1.26	1.5
Canara Robeco Nifty Index – Growth	1.45	?
Birla Sun Life Index Fund – Growth	1.76	1.51
LIC MF Index Fund – Nifty Plan – Growth	1.99	1.5
HDFC Index Fund – Nifty Plan	2.55	1.5

 

We see that the index funds have a pretty significant tracking error compared to the Nifty BeES along with almost double (and sometimes triple) the expenses [double whammy – greater tracking error as well as more expenses!]

Based on the above data, it is pretty safe to conclude that if the objective is to mimic Nifty returns, your best bet would be to invest in Nifty BeES.

However, there is another nuance to this whole investing in Nifty BeES vs Index funds (and the point of this post – took too long, eh?). What about brokerage charges? Do they impact our returns? Especially when we SIP.

Mutual Funds have been forbidden (from August 2009, I think) to charge any entry loads on any of their funds. Almost all index funds do not have an entry load and have an exit load of 1% only if you exit the fund before 1 year of that investment. Technically, if you are a long term investor (say > 1 year) and are SIPing into an index fund, there is no expense other than the Expense ratio (which varies from 0.5%-1.5%).

SIPing into Nifty BeES however would involve brokerage charges. I use Sharekhan and they charge 0.25% on every purchase of Nifty BeES (or any other stock for that matter) and 0.25% on every sell. So, when you SIP, you are technically paying 0.25% every month, along with an expense ratio of 0.5% every year and 0.25% again when you sell.

How do the returns stand now? Let me illustrate with an example. We assume a simple scenario where there has been no growth in Nifty returns (or 15% growth. We assume there is zero tracking error). How would Nifty BeES vs Index funds stack up?

Period	Nifty BeES	Actual amount invested after brokerage of 0.25%	Index funds	Actual amount invested after entry load of 0%
1	10000	9975	10000	10000
2	10000	9975	10000	10000
3	10000	9975	10000	10000
4	10000	9975	10000	10000
5	10000	9975	10000	10000
6	10000	9975	10000	10000
7	10000	9975	10000	10000
8	10000	9975	10000	10000
9	10000	9975	10000	10000
10	10000	9975	10000	10000
11	10000	9975	10000	10000
12	10000	9975	10000	10000
Total Amount Invested		119700		120000
Expense ratio	0.50%	598.5	1%	1200
Brokerage on selling after 1 yr	0.25%	299.25	0%	0
Total returns		118802.25		118800
Difference in amount in returns between Nifty BeES and Index funds	2.25

 

As you can see from the table, the difference is just Rs. 2.25/- on amount of Rs. 1,20,000. A miniscule percentage difference between investing in Nifty BeES and Index funds. Conclusion? The expense ratios of Index funds, although slightly larger is not directly comparable to the expense ratio of Nifty BeES.

However, Tracking error seems to be a huge problem and you see the difference in returns below for some funds which have been in the market for > 5 years (apart from tracking error, Index funds usually have 5% of their portfolio in cash to service redemptions and hence the returns might not exactly mimic Nifty and hence the difference in returns) –

Fund Name	Launch Date	Returns(%)	Expense ratio (%)
Canara Robeco Nifty Index	Oct-04	7.38	1
HDFC Index Nifty	Jul-02	6.6	1
Nifty Benchmark ETS	Dec-01	8.29	0.5

 

Therefore, investing in a Nifty ETF is much better (atleast for the additional 1-2% return) than any Index funds available in the market, even if you SIP it, brokerage costs included. I don’t see a reason why you need to invest in an Index fund.

A similar analysis can be done for Liquid BeES vs a Savings account –

 

Column1	Liquid BeES	Savings A/C
Amount Invested	10000	10000
Avg. return over a 5 year period (from valueresearchonline.com)	5%	3.50%
Interest earned	500	350
Brokerage costs (buy and sell)	50	0
Total amount	10450	10350
Difference	100

 

Investing in a Liquid BeES is much better than keeping your money idle in a Savings A/c (even after brokerage of buying and selling). Some brokerages don’t charge (Sharekhan does!) while you invest in Liquid BeES. Even better returns.