With the stock markets zooming and the benchmark indices touching new life time highs almost on a daily basis there is a renewed interest to invest in equity .The retail investor has learnt over the years that though a risky asset, finally it is the returns from equity markets that can skew favorably in achieving his financial goals if an approach of early investing, disciplined financial planning, investing for the long term and benefits of compounding are packaged as a portfolio.

Towards this goal the choice naturally is to invest though the mutual fund (MF) route rather than take risk of directly investing in stocks. Competition in the MF industry has ensured innovative products being offered to capture a slice of the large retail investor market.

Today there are more than 143 offerings in the equity diversified scheme (EDS) category itself, making choice difficult. To top it further there are Exchange traded Funds (ETFs) being offered as one more option. With more and younger population going online, intermediation is on the wane. The recent offering of Goldman Sachs CPSE mobilized a thumping Rs.3000 crs. a record of sorts in the industry. In such a backdrop should one select ETFs or invest in open ended EDSs? In order to make an informed choice, one needs to understand both these products on the risk return matrix and then match it to ones own investment horizon and risk appetite.

Typically equity ETF tracks a market index like the Nifty or Bank Nifty. Thus there is a risk of concentration as there is high weightage of 2-3 stocks or a sector in the benchmark itself. Some may have international exposure as well. An open ended EDS on the other hand could benchmark itself with Nifty or broader indices such as BSE100, CNX Midcap or S&P CNX 500 and tend to have in its portfolio a more diversified basket than the benchmark. Thus in a bull run an actively managed EDS could tend to give a better return than an ETF which is a passive fund. E.g. During the month of April 2014, while Nifty gave a 3 % return the CNX Midcap clocked a 6 % return. So an aggressive investor with a longer time horizon would tend to get better returns through investments in EDS.

Internationally, ETFs are considered low cost products as the fees are much lower than a MF product. In India however the fees range between 1 to 1.5 % and the investor has to incur further cost of brokerage and STT as the product is transacted on an exchange. Also a demat account has to be opened and maintained, which entails additional cost though very minimal. EDS on the other hand charge fees between 1.75% to 2.25%.So there is a very thin difference on this front although comparatively ETF tends to be a cheaper option.

The ETF portfolio being passively managed is transparent and the stocks with weightings being replicated like an index are known before investing while one has to wait for the monthly fact sheet to know the investment strategy of an EDS. ETFs also score over a close end EDS as the liquidity is far greater although it is still an issue as equity ETFs are yet not all that popular like the gold ETF. Also ETFs could fall prey to freak trades or concerted punting as was witnessed in one of the ETF in 2006. On the other hand there are several EDSs with long term track records that have clocked more than 20% CAGR for 14 -20 year period and consistently outperformed the benchmarks.

However the key differentiator between an equity ETF and EDS is that an ETF is traded online at real time while in case of an EDS one tends to get end of day NAV. The difference further smoothens out for an investor with a long term focus. Yet market analysts always advise that a small portion of the portfolio say 10 -15 % should be a trading portfolio. This could be achieved by buying and selling either stocks or futures. However trading in futures needs a higher risk appetite as they are leveraged positions. Should the call go wrong, albeit temporarily, one has to chip in additional margin to hold that position .A prolonged wait or an overnight change in market momentum due to sudden bad news could prove to be hazardous. In absence of ability to fund the margin, one will have to per force close the position with huge loss. It is here that ETFs can prove to be a useful tool for handling trading ideas. It is a golden middle path which does not have hard risk of the futures market and yet has ability to give better returns than a buy and hold portfolio.

Moreover ETFs are subject to short and long capital gains unlike futures which are considered as business income and attract the maximum marginal tax rate on gains.

Thus on a risk return matrix ETFs are restricted diversified products while EDSs are largely diversified across sectors which lower risk and have a high possibility of outperforming ETFs in a bull run.

Anagha Hunnurkar (The author is an investment professional from Mumbai. She is working as a Senior consultant in the area of wealth management and corporate advisory services.)