7/31/2019 ETFs Simplified

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The new launch by the NSE of weighted indices in order to sell products that provide sector exposure

and diversified risks are welcomed to those advocating diversified and innovative products. Indeed we

will see increased market liquidity as these products are taken up by investors, especially foreign levered

capital.

The currently proposed Exchange Traded Funds will provide greatly required diversified marketexposure. ETFs are quite simple really. An issuer will raise capital (equity) in a fund that offers returns as

a function of an index. The fund then issues proportional shares to the capital raised at outset, if the

fund is close-ended. If open-ended, a rebalancing is done on the open dates. These shares are then

tradable on the exchange.

Depending on how the trading floor is, investors will see if the net asset value of the fund (i.e. actual

shares) is reflected in the price of the fund. If the NAV is above the ETFs market value, an investor

would ordinarily sell out, and vice versa. At the end of day, the fund will publish its net asset value and

closing price of shares for the next days business.

Indeed this would be an uphill task for a direct market participant seeking similar exposure as every

unit's price movement would require a corresponding rebalancing of the portfolio. With T+3days

confirmation, such a portfolio would have a 3 day lag from the real market, if the portfolio is to have

100% tracking of the index: Simply IMPOSSIBLE! Thus ETF's are very much appreciated, specifically for

those seeking market segment exposure (which is beneficial in averaging risk), such as mutual and

pension fund managers.

In the proposed ETFs, only upside returns are offered. This means that only on rise of the base index will

positive returns on capital be booked. This limits alternative investment desks, especially with foreign

capital seeking top-notch (alpha) returns.

I am concerned about what kind of exposure would be provided in these ETFs. How will CMA enforce

100% tracking of basis indices by the ETFs issuer considering the T+3 lag in the real market? Are Mark-

To-Market procedures been put in place and what kind of logistics will disbursements involve? Are

capital reserves going to be put in place for this process?

All in all, we are headed in the right direction. CMA should propose laws allowing shorting, so as to allow

proper hedging of down-side risks. KRA should issue a directive before such funds are floated, as back-

dating taxes would be a cumbersome and almost impossible task. It is also worth noting that the basis

indices that have been created should now permit financial engineers to use local market-based

variables in the creation of market tradable derivatives