The allure of international stocks is undeniable. But the path to accessing them has become increasingly narrow for Indian investors.
For years, Indian mutual funds offered a convenient route to global diversification. However, regulatory limits on overseas investments, breached in 2022, have effectively shut the door on fresh inflows into most global schemes. This includes overseas ETFs, which can no longer create new units to satisfy the growing appetite.
The result? Investors are crowding into a limited number of ETFs already trading on local exchanges, driving up their prices to unsustainable levels. It’s a classic case of supply and demand, but with a potentially painful twist.
Normally, an ETF’s market price should closely mirror its Net Asset Value (NAV) – the real-time value of its underlying holdings. However, the current frenzy has decoupled these two metrics. With no new units being created, the high demand for existing ETF units has pushed prices far beyond their actual value, creating a significant premium.
Consider the Mirae Asset FANG+ ETF, which recently traded at a premium exceeding 21% of its NAV. The Mirae Asset S&P 500 Top 50 ETF and the Nippon India ETF Hang Seng BeES have shown similar trends, trading at premiums of 21% and 19% respectively. Even the popular Motilal Oswal NASDAQ 100 ETF has seen its price inflated by nearly 8% above its NAV.
The danger lies in the inevitable convergence of ETF prices and their NAVs. As Vivek Banka, Co-founder of Goalteller, points out, “Sooner or later, this premium will evaporate as the ETF traded price aligns with its NAV, which can lead to a capital loss.”
Imagine investing ₹1 lakh in an ETF trading at ₹120 per unit, with an iNAV (indicative NAV) of ₹100. If the underlying assets grow by 10%, the iNAV rises to ₹110. But if the premium disappears, your investment is now valued at ₹91,667 – a loss despite the growth in the underlying assets.
The distortion doesn’t stop at ETFs. Investors in Fund-of-Funds (FoFs) that invest in these ETFs are also exposed to the premium risk. The FoF’s NAV is often calculated based on the ETF’s inflated closing price, rather than its NAV, leading to an artificially higher return.
Siddharth Srivastava, Head-ETF Product & Fund Manager at Mirae Asset Investment Managers (India), acknowledges the issue: “If the ETF trades at a premium, the FoF valuation provides an inaccurate picture of the ETF’s underlying performance. When the premium subsides, the FoF return will also diminish.”
With the Reserve Bank of India (RBI) maintaining restrictions on overseas mutual fund investments, the situation isn’t expected to change anytime soon. So, what should investors do?
- Exercise Caution: Avoid overpaying for overseas ETFs, even if the potential returns seem attractive.
- Monitor iNAVs: Regularly check the indicative NAVs published by fund houses and stock exchanges to assess the premium.
- Consider Alternatives: Explore overseas funds operating in GIFT City or opening a foreign trading account (though the latter can be costly and cumbersome).
- Book Profits: If you’re sitting on substantial gains from overseas ETFs, consider booking profits before the premium shrinks.
Kunal Valia, Founder of StatLane, a Sebi-registered Research Analyst, emphasizes the need for parity in valuation norms between ETFs and FoFs. He suggests that “FoFs investing in ETFs should be valued based on the closing NAV of the underlying ETF rather than its traded market price.”
The current situation highlights the delicate balance between investor demand, regulatory constraints, and market efficiency. While the allure of global markets remains strong, investors must tread carefully and avoid getting caught in the global ETF premium trap. The long-term success of these investments hinges not only on the performance of foreign markets but also on the unpredictable dynamics of ETF pricing.
