Are ETFs the right tool when markets are at an all-time high? – Financial News

As markets reach new highs, investors often face a critical decision: should they stick with traditional asset classes like mutual funds or consider more dynamic options like exchange-traded funds (ETFs)? In the mature stages of a secular bull market, the right investment strategy is critical, and we believe ETFs can offer a compelling solution for navigating the complexities of a market that is at all-time highs and whose valuations are lofty.

What distinguishes ETFs?

Exchange-traded funds (ETFs) are investment vehicles that track specific indices, assets, sectors or themes, providing exposure to a diversified basket of securities. Unlike individual stocks, which carry the risk of large price fluctuations, ETFs offer built-in diversification. This feature is particularly beneficial when markets are at record highs, as it helps mitigate the risk associated with individual stock investments.

For example, June 2024 was a very positive month for Indian equities. However, if you had bought individual stocks just before the election results were announced on June 4, your portfolio could actually be in the red for the month, as many of the stocks never returned to pre-election levels. However, by investing in an ETF that tracks the Nifty 50 or another broad-based index, you can spread your risk across a portfolio of securities, minimizing the potential impact of a single stock's downturn.

Also read: 1-year vs. 2-year fixed deposit: Which offers the better return?

Lower volatility, higher stability

One of the outstanding advantages of ETFs is their lower beta, which measures the volatility of an investment relative to the market. According to a 2024 Morningstar India report, the average beta for Indian equity ETFs is around 0.85, significantly lower than that of individual stocks. This means that ETFs are generally less volatile, making them a more stable choice in a mature bull market where outcomes can be highly unpredictable.

Thematic and sectoral opportunities

Investing in individual stocks doesn't always provide immediate access to new themes or industries. That's where thematic ETFs come in. Whether it's the rise of electric vehicles (EVs) or the growth of renewable energy, ETFs allow you to invest in long-term trends by giving investors access to an entire value chain and ecosystem of a particular theme across a wide range of companies. This can include everything from large corporations to smaller companies at the forefront of innovation.

Identifying undervalued sectors is also crucial when markets are at their peak. ETFs that focus on emerging or undervalued sectors within the broader basket of securities allow investors to tap into potential growth areas that may not yet be fully priced in.

Cost efficiency and liquidity

In a volatile and expensive market, keeping costs low is more important than ever. ETFs generally have lower expense ratios than actively managed funds, so more of your money is working for you. This cost efficiency becomes especially valuable when markets peak, as higher costs can reduce returns.

Additionally, ETFs offer liquidity, allowing you to easily open and close positions as the market moves. This flexibility is critical during a bull market, where rapid portfolio adjustments may be necessary to profit from market movements.

Potential for alpha generation

ETFs are often seen as a way to gain broad market exposure, but they also offer the potential to generate alpha – returns above the benchmark. By investing in ETFs that target undervalued sectors or smart alpha/beta strategies, you can achieve higher alpha compared to traditional mutual funds.

The growing popularity of ETFs in India

By 2024, the total assets under management (AUM) for ETFs in India will have reached about Rs 6.5 trillion (Rs 6.5 lakh crore). India will have over 140 ETFs by 2024. This investment vehicle is gaining significant traction in the Indian markets as investors are looking for more passive investment options. ETFs have become a popular choice not only in the US but increasingly in the Indian market as well. In fact, India-based ETFs topped the charts of inflows into emerging market ETFs in the US in June 2024 with inflows of $497 million.

A balanced approach to bull markets

ETFs offer a number of benefits that make them an attractive option when markets are at all-time highs. Their built-in diversification, lower volatility, cost efficiency, wide choice and potential exposure to thematic trends provide a strategic advantage when navigating high market valuations. As the Indian market continues to evolve, adding ETFs to your investment portfolio could be a smart move to generate smart alpha. This allows investors to capitalize on the best growth opportunities while effectively managing risk in a complex and ever-changing volatile market environment.

(By Amit Goel, Co-Founder and Chief Global Strategist, Pace 360)

Disclaimer: The views, recommendations and opinions expressed are personal in nature and do not reflect the official position or policy of FinancialExpress.com. Readers are advised to consult qualified financial advisors before making any investment decisions. Unauthorized reproduction of this content is prohibited.