A reader asks, “Sir, can we use Sensex or Nifty ETFs for long term goals instead of index funds? If so, which is better, Sensex or Nifty ETFs?”
We recommend not using any ETF for investing because of possible price-NAV swings during times of crisis and their persistence for weeks. This can happen in any ETF regardless of AUM and typical trading volumes. This is an unnecessary headache for long term investors at the time of rebalancing and eventual redemptions.
Index funds will get the job done without hassle. Index fund tracking errors are typically lower than ETF tracking errors (when measured with price, see explanation below), making them better suited for long-term investing. For data, see the screeners linked below.
Many investors believe ETFs are better than index funds because of their low expense ratios. This is incorrect. Only an ETF with low price-NAV deviations can match up to an index fund. The price-based tracking error will help us search for such ETFs. See ETFs vs Index Funds: Stop assuming lower expenses equals higher returns!
ETFs (at least Indian ETFs at the time of writing) should only be used for trading after considering how quickly price-NAV deviations are extinguished. We compare the tracking errors of Sensex and Nifty ETFs to find out which is better for trading.
From an index standpoint, there is little to distinguish between the Sensex and the Nifty. The Nifty has 50 stocks with the largest free-float market capitalization traded at the NSE. The Sensex has the corresponding 30 stocks traded at the BSE. Since the weights are determined by the free-float market cap, the top 10 stocks in both indices account for 60% or more of the total weight in the NIfty and about 70% in the Sensex. See: Do index fund returns depend upon just a few stocks (Concentration risk)?
As a result, the extra 20 stocks in the Nifty do not contribute much to shaping index risk or reward. As a result, there is barely any difference between the two indices. See: Nifty vs Sensex: Which should I choose for passive investing?
However, when these indices are put into a product like an index fund or an ETF, the tracking error, the AUM, the volumes traded, and the expense ratio determines the investor’s actual risk or reward.
Regarding index funds, we have repeatedly shown that some Sensex funds can compete with Nifty funds. So at least in principle (and limited practice), both index funds have similar efficiency in tracking the index as measured by the tracking error. See Index fund tracking error screener August 2022.
Thanks to the ETF tracking error screener Aug 2022, we are now in a position to compare Sensex and Nifty ETFs.
The tracking error is the ETF’s standard deviation minus index monthly return differences. The lower the tracking error, the more efficient the ETF is in following the index.
In an index fund, there is only the NAV. In an ETF, the units are typically traded during market hours like stock with an associated price determined by supply and demand. An AMC-appointed intermediary is supposed to keep the price close to the NAV, but often this does not happen.
The fund manager must ensure the NAV tracks the benchmark in an index fund. In an ETF, not only should the NAV track the benchmark, but the price also should track the benchmark (or equivalently track the NAV).
ETF tracking errors are usually reported using the NAV. The tracking error or tracking difference information does not tell us if the price follows the NAV closely. We will have to guess this by looking at trading volumes. The ETF screener will help change that.
As we have repeatedly shown, tracking NAV-based tracking errors seriously is a big mistake. See, for example, Conventional ETF tracking errors can be misleading here is how to correct them. This link also has examples of how the tracking error is computed.
We buy and sell ETF units at market price; therefore, the price should be used to compute tracking errors and tracking differences. An ETF with a low NAV-based tracking error can have a high price-based tracking error. This means that the ETF price is not tracking the NAV properly.
By measuring tracking error with the ETF price, we can instantly know how efficiently the ETF is tracking the benchmark. Or, in other words, how efficient the AMC-appointed intermediary is in arbitraging the price-nav differences. An efficient intermediary can help minimise price-nav deviations even in low-AUM ETFs. Also, high AUM does not mean price-NAV deviations are automatically low in the ETF.
The last 1Y tracking errors calculated from the ETF price are shown below. The x-axis is just the ETF serial no and can be ignored. There are 16 Nifty ETFs with a 1Y history at the time of writing and 9 Sensex ETFs.
One can see from the distribution of price-based tracking errors that 7 Nifty ETFs are better at tracking the index. Only two Sensex ETFs are below the median value of all NIfty ETFs.
What does this mean?
- Price-NAV deviations in Sensex ETFs are much higher than in popular Nifty ETFs.
- This probably means Sensex ETF trading volumes are typically lower than (popular) Nifty ETF trading volumes.
- Sensex ETFs are therefore less suited for trading compared to Nifty ETFs. We recommend not trading in Sensex ETFs.
- We would also like to reiterate our thumb rule to not use any ETF for investing.
Do share this article with your friends using the buttons below.
Use our Robo-advisory Excel Tool for a start-to-finish financial plan! ⇐ More than 1000 investors and advisors use this!
- Do you have a comment about the above article? Reach out to us on Twitter: @freefincal or @pattufreefincal
- Join our YouTube Community and explore more than 1000 videos!
- Have a question? Subscribe to our newsletter with this form.
- Hit ‘reply’ to any email from us! We do not offer personalized investment advice. If you have a generic question we can write a detailed article without mentioning your name.
Explore the site! Search among our 2000+ articles for information and insight!
About The Author
Dr M. Pattabiraman(PhD) is the founder, managing editor and primary author of freefincal. He is an associate professor at the Indian Institute of Technology, Madras. He has over nine years of experience publishing news analysis, research and financial product development. Connect with him via Twitter or Linkedin or YouTube. Pattabiraman has co-authored three print books: (1) You can be rich too with goal-based investing (CNBC TV18) for DIY investors. (2) Gamechanger for young earners. (3) Chinchu Gets a Superpower! for kids. He has also written seven other free e-books on various money management topics. He is a patron and co-founder of “Fee-only India,” an organisation for promoting unbiased, commission-free investment advice.
Our flagship course! Learn to manage your portfolio like a pro to achieve your goals regardless of market conditions! ⇐ More than 2800 investors and advisors are part of our exclusive community! Get clarity on how to plan for your goals and achieve the necessary corpus no matter what the market condition is!! Watch the first lecture for free! One-time payment! No recurring fees! Life-long access to videos! Reduce fear, uncertainty and doubt while investing! Learn how to plan for your goals before and after retirement with confidence.
Our new course! Increase your income by getting people to pay for your skills! ⇐ More than 675 salaried employees, entrepreneurs and financial advisors are part of our exclusive community! Learn how to get people to pay for your skills! Whether you are a professional or small business owner who wants more clients via online visibility or a salaried person wanting a side income or passive income, we will show you how to achieve this by showcasing your skills and building a community that trusts you and pays you! (watch 1st lecture for free). One-time payment! No recurring fees! Life-long access to videos!
Our new book for kids: “Chinchu gets a superpower!” is now available!
Most investor problems can be traced to a lack of informed decision-making. We have all made bad decisions and money mistakes when we started earning and spent years undoing these mistakes. Why should our children go through the same pain? What is this book about? As parents, if we had to groom one ability in our children that is key not only to money management and investing but to any aspect of life, what would it be? My answer: Sound Decision Making. So in this book, we meet Chinchu, who is about to turn 10. What he wants for his birthday and how his parents plan for it and teach him several key ideas of decision making and money management is the narrative. What readers say!
Must-read book even for adults! This is something that every parent should teach their kids right from their young age. The importance of money management and decision making based on their wants and needs. Very nicely written in simple terms. – Arun.
Buy the book: Chinchu gets a superpower for your child!
How to profit from content writing: Our new ebook for those interested in getting side income via content writing. It is available at a 50% discount for Rs. 500 only!
Want to check if the market is overvalued or undervalued? Use our market valuation tool (will work with any index!), or you buy the new Tactical Buy/Sell timing tool!
We publish mutual fund screeners and momentum, low volatility stock screeners every month.
About freefincal & its content policy Freefincal is a News Media Organization dedicated to providing original analysis, reports, reviews and insights on developments in mutual funds, stocks, investing, retirement and personal finance. We do so without conflict of interest and bias. Follow us on Google News. Freefincal serves more than three million readers a year (5 million page views) with articles based only on factual information and detailed analysis by its authors. All statements made will be verified from credible and knowledgeable sources before publication. Freefincal does not publish any paid articles, promotions, PR, satire or opinions without data. All opinions presented will only be inferences backed by verifiable, reproducible evidence/data. Contact information: letters {at} freefincal {dot} com (sponsored posts or paid collaborations will not be entertained)
Connect with us on social media
Our publications
You Can Be Rich Too with Goal-Based Investing
Published by CNBC TV18, this book is meant to help you ask the right questions, and seek the correct answers, and since it comes with nine online calculators, you can also create custom solutions for your lifestyle! Get it now.
Gamechanger: Forget Startups, Join Corporate & Still Live the Rich Life You Want
This book is meant for young earners to get their basics right from day one! It will also help you travel to exotic places at a low cost! Get it or gift it to a young earner.
Your Ultimate Guide to Travel
This is an in-depth dive analysis into vacation planning, finding cheap flights, budget accommodation, what to do when travelling, and how travelling slowly is better financially and psychologically with links to the web pages and hand-holding at every step. Get the pdf for Rs 199 (instant download)
