Global ETF craze has retail buyers paying steep premiums

Mumbai: Retail investors, drawn by the superior returns from international markets compared to local equities in the last year, are rushing to allocate money to mutual fund schemes that bet on overseas equities. Amid the dash to put money in these top performers, they are overlooking a crucial detail: many of these exchange-traded funds are at a 20-25% premium to their current values, leaving them exposed to any sharp reversals.

Currently, many of these schemes do not accept fresh subscriptions because they have hit the central bank’s overseas investing limit for mutual funds. The industry currently operates under a $7-billion limit for international mutual fund schemes and an additional $1-billion window for ETFs. The industry first hit this ceiling in February 2022, and since then, only schemes that haven’t exhausted their individual limits – or those where redemptions have freed up space – have been able to accept subscriptions. This resulted in a sharp spike in demand for ETFs, which are traded like stocks on exchanges – with investors buying them at premiums to their net asset values – the daily prices.

“Retail investors blindly buy ETFs, and there is no attempt to look at the premium or discount to the NAV,” says Chetan Nandani, founder, Prime Care Investments.

Currently, the Nippon India Hang Seng ETF trades at a 21% premium to its NAV, while the Mirae Asset Hang Seng Tech ETF trades at a premium of 23%. The Mirae Asset S&P 500 Top ETF trades at a premium of 18%, the Mirae Asset NYSE Fang+ ETF at 19%, while the Motilal Oswal Nasdaq 100 ETF trades at a premium of 2-3%.

“Overseas ETFs can no longer create new units to meet additional demand. However, since they trade on the exchanges, investors can still buy in the secondary markets,” says Kunal Valia, founder, Statlane – a Sebi-registered research analyst. “This has led to crowding into a handful of overseas ETFs, due to which these ETFs are trading at a premium way higher than the NAV.”

As per data from Value Research, international funds, on average, have returned 28% over the last year, compared with Nifty’s 12.8%.
RBI-imposed overseas limits have kept many US-focused mutual fund schemes shut for fresh subscriptions. While investors can bypass these curbs by using the Liberalised Remittance Scheme to buy ETFs abroad, the route comes with high transaction costs and the added hassle of separate brokerage accounts and compliance paperwork. Another alternative is to buy international funds set up in GIFT City, but the minimum investment of $5,000 makes it accessible only to larger-ticket investors. Investors who bought these international ETFs from the secondary market run the risk of sharp drawdowns if the RBI eventually decides to lift this limit. In such an instance, the lofty premiums on many of these products could evaporate quickly.

“Such investors carry a huge risk. The premium on these funds can disappear overnight if RBI were to increase or open up the limits,” warns Nandani. “If that happens, such investors could see a straight capital loss of 20-25% on these ETFs.”