In this article, we see how a lower expense ratio does not necessarily mean more gains for the investor using the example of two index funds: the NAVI Nifty 50 Index fund (direct plan) and the UTI Nifty 50 Index fund (direct plan) and the last one year period.
It must be understood that the motive behind this article is only to highlight some counterintuitive features of passive funds. It should not be construed as a recommendation of one fund over another. The NAVI fund is too young to be dismissed or recommended.
Navi Nifty 50 Index Fund: Started in July 2021, the fund has an impressive AUM of about 571 Crores. Much of this AUM came due to the advertised “lowest fee”. The fund, since inception, has maintained a total expense ratio (TER) of only 0.06%
UTI Nifty 50 Index Fund: This has an AUM of about 8,941 Crores, and during the last year, the funds’ TER has fluctuated from 0.21% to 0.18% with an average TER of about 0.2%. The fund was started in March 2000, but as is common knowledge, much of its AUM is a recent acquisition. The fund notoriously doubled its TER (0.1% in March 2021 to 0.2% in May 2021) but still managed to stay on top in terms of performance.
Notice that the tracking error does not differentiate between the two funds. This is because removing a constant TER from the NAV does not affect the tracking error, which is a measure of relative volatility wrt the benchmark. We ask readers to focus on the tracking difference (fund return minus benchmark return) and use it in our monthly index fund screeners.
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| Scheme Name | Tracking error 11-Nov-2021 To 11-Nov-2022 |
| UTI Nifty 50 Index Fund(G)-Direct Plan | 0.0432 |
| Navi Nifty 50 Index Fund(G)-Direct Plan | 0.0437 |
This is the trailing performance of the two funds compared with Nifty 50 TRI
| Scheme Name | 3 Months | 6 Months |
| Navi Nifty 50 Index Fund(G)-Direct Plan | 4.0816 | 14.5493 |
| UTI Nifty 50 Index Fund(G)-Direct Plan | 4.0868 | 14.5644 |
| NIFTY 50 – TRI | 4.1400 | 14.7067 |
| Scheme Name | 9 Months | 1 Year |
| Navi Nifty 50 Index Fund(G)-Direct Plan | 6.6740 | 3.7819 |
| UTI Nifty 50 Index Fund(G)-Direct Plan | 6.7076 | 3.8107 |
| NIFTY 50 – TRI | 6.9047 | 4.0658 |
The UTI fund, with a TER more than three times that of the NAV fund, has managed to perform just as well. How is this possible?
(1) All index funds can invest in “money market instruments” up to 5% of the portfolio to handle cash in and outflows. These can be a variety of instruments like short-term deposits, treasury bills, commercial paper, tri-party repo, securities lending etc. The fund can choose these instruments per prevailing market or economic conditions.
A fund with a higher return from this money market component can easily offset its higher TER and produce a better or comparable return to a fund with a lower TER. Of course, this comes with some settlement risk and can backfire under extreme market conditions. This is a more or less steady return and will not contribute much to the tracking error.
(2) Another possible reason is the impact cost. The buy-price and sell-price of stock in the market often depend on the quantity sold. This results in a loss or a gain for the buyer/seller. For more details, see Warning! Even “large cap” stocks are not liquid enough!
For a stock to be eligible for inclusion in the Nifty 50, its average impact cost should be 0.5% or less for 90% of its transactions over the last six months for a basket size of Rs. 2 crores. The impact costs of the top few stocks of the Nifty are the lowest, but they do increase by two to three-fold as the market capitalization decreases. The NSE provides monthly impact cost reports for both the Nifty 50 and Nifty Next 50 (The next 50 stocks have a much higher impact cost and, therefore, should not be classified as “large cap”).
These impact costs or demand-supply losses may be lower (especially for top Nifty 50 stocks) for a fund with a large AUM since their buy/sell orders are larger. However, this cannot be quantified easily (at least by us) and therefore remains speculation.
This discussion also has another aspect. UTI Nifty 50 index fund can compete with NAVI Nifty 50 index fund despite being three times more expensive. This is largely due to how well they manage their cash component. But does this mean they are taking more risks to enable them to maintain a higher TER? Does this mean it can hurt investors (by a small amount)? This is certainly a possibility. Only time can tell.
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