There is a saying in Wall Street that in the long term the market always goes up. So, it stands to reason that investing in the broad market will yield results in the long run.
Doing so will also remove the hassles of keeping up with the market or paying significant fees to asset managers who will keep up with the market for you. Enter ETFs and Index Funds.
An ETF or Exchange Traded Fund is a collection of investments, such as stocks, that can be traded on the stock exchange just like any stock of a company. It usually holds multiple underlying assets, rather than only one like a stock.
As there are multiple assets within an ETF, they can be a popular choice for diversification. An ETF can own hundreds or thousands of stocks across various industries, or it could be isolated to one particular industry or sector.
For example, banking-focused ETFs would contain stocks of various banks across the industry.
Index Funds are also based on similar principles. They were introduced in 1973, 20 years before the first ETF. The key difference between Index Funds and ETFs is that Index Funds are not traded on the market like regular stocks. They can be bought through brokerages or directly from Index Fund providers.
Isn’t that a Mutual Fund?
One of the key qualities of popular ETFs and Index Funds is that they are passive funds. Unlike actively managed funds, such as Mutual Funds, which try to beat the market, Index Funds, and ETFs rise and fall with the market.
One of the most popular Index Funds is the S&P 500. Here the Index Funds and ETFs contain stocks of the S&P 500, a collection of the 500 largest publicly listed companies in the USA.
The performance of the S&P 500 index directly impacts the performance of the ETFs and Index Funds.
On the other hand, a Mutual Fund contains stocks of fewer companies selected by the asset manager, and the composition of the mutual fund can be changed on a daily or even hourly basis. Mutual funds are actively managed and historically actively managed funds are out-performed by the broad market.
ETFs and Index Funds have become instrumental in the US capital market. These have allowed small regular investors to invest in the broad market.
According to research from Morningstar Inc, Index Funds and ETFs made up 14 per cent of the US stock market on the 31st of August, 2019, surpassing their stock-picking rivals such as mutual funds and hedge funds.
This number doubled from 2010, as more and more people lost faith in their money managers following the stock market crash of 2008. These indexed equities are usually passively managed using automation. T0his drives down the cost of managing portfolios which translates to lower commissions and fees for individual investors.
Low fees and commissions, lower levels of risks, and better chances of returns have compelled many individuals, especially young investors, to invest in Index Funds and ETFs.
The Case for Bangladesh
At the end of 2019, the Bangladesh Bank set the maximum deposit rate for banks at 6 per cent. This deposit rate cap made bank deposits less attractive for individuals. In such a case, the stock market would have been a great place for investors.
But the historically turbulent nature of the local stock market and lack of financial literacy has kept many from investing their hard-earned money in the stock market.
However, despite their popularity in the USA and even our neighbour India, Index Funds and ETFs have not been able to gain traction in Bangladesh.
While there are no regulatory provisions for Index funds in Bangladesh yet, a regulatory framework was prepared for ETFs back in 2017. But no ETF has yet been launched in Bangladesh.
A mutual fund manager seeking anonymity said, “The Bangladeshi asset market is far from being mature enough for ETFs. As ETFs have many underlying securities in each of them, the market needs to have these securities to accommodate the creators of ETFs.”
He also pointed out that Bangladesh has no bond market, which is a hindrance to these kinds of wide market funds being viable.
Furthermore, ETFs require the presence of market makers who work as a sort of middlemen. The market makers work towards liquidating ETFs when they are sold off by the investors.
The absence of market makers makes ETFs completely unviable in Bangladesh. As of now, the concept of Index Funds and ETFs remains a future dream in Bangladesh.
However, with the right steps from the regulatory bodies and a shift in investor mindset, these broad market diversified funds might become feasible in the near future.