Global Opportunities

Exchange Traded Funds (ETFs) as a concept has gained a lot of ground in the Indian markets over the past couple of years. The advanced infrastructure of ETF based investing in the Western markets have nudged our market participants to adopt it too. 

For the uninitiated, ETFs are financial instruments (read: basket) that track a particular index, commodity, or a group of stocks. It trades on the exchange – just like stocks. For example, the Nifty Index consists of 50 stocks. So if one wants to invest in the Nifty index, one can just buy the Nifty ETF, instead of buying all the 50 stocks in the same proportion as the Index. If the Nifty generates a return of 5%, the Nifty ETF will also generate approximately the same returns. Similarly, investing in a gold ETF will allow investors to earn the returns of investing in physical gold. As logic would guide, the price movement of a concerned ETF would be similar to the price movements of the underlying security or group of securities. 

Now, there are multiple reasons attached to the traction in the ETF space, let me outline a few here –

• Low cost investing – ETF instruments are passively managed vehicles that do not warrant frequent churn (churn refers to change in the portfolio of stocks due to frequent buying and selling) and hence cut down on the transaction costs. This in turn is the reason behind the low churn for ETF based smallcases. Since, ETFs are an amalgamation of stocks, the need to take calls on selective companies does not arise. Opposing this, if we have exposure towards 5 different stocks, specific calls need to be made on individual businesses. The minimum investment amount is on the modest side too as ETF based smallcases are designed to cater to the larger audience, especially an average retail investor. The cost efficiency on account of lower expense ratio helps the case of modest investable amount.
• Diversification – The structure of the product is such that it offers rich diversification within the same asset class. This diversification primarily comes from a sectoral point of view, where stocks belonging to varied industries are pooled into a single ETF. We shall talk about this in greater detail, going forward, with a specific case in point.
• Risk element – ETFs have a lower risk-element attached to it as the risk-reward is highly favorable for any investor. The reason being that with a modest capital disbursement one gets exposed to a variety of quality stocks, thereby mitigating a good portion of stock-specific risk.

At Windmill Capital, we have a dedicated focus towards building an ETF based smallcase, i.e. a portfolio that hold ETFs of different varieties. The reckoning within the team is that ETF based smallcases are a fairly prudent way to build your core portfolio.

So, how do we go about building such smallcases? We follow a set process for the same. To begin with, the smallcase idea is seen from a bird’s eye view to check for what it offers and how different investors can benefit from it. Then, we make a roster of the most liquid ETF instruments in the market, representing the relevant asset classes that we wish to include in our smallcase universe. Next up, we back-test the smallcase to gauge its performance in various market scenarios including extreme bear/bull market to a prolonged sideways market (sideways markets refer to when prices remain almost constant over time). This helps us deploy smart weighting schemes. Essentially, the stress-testing lays out different performance scenarios in front of the team and that aids decision-making as far as weight allocation is concerned. And finally, we take a final call on whether the ETF smallcase is good to launched for investors, keeping the first step closely in mind.

The following page would see detailing of the All Weather Investing smallcase, starting from how it was conceived to investor suitability –

Global Opportunities

True to its name, Global Opportunities smallcase invests into both Indian as well as international equities. The smallcase has a proclivity towards international tech companies that have proved to be exceptional wealth creators for investors. It currently holds 3 ETFs – Nippon India Nifty 50 Bees ETF, Nippon India Junior Bees ETF, and Motilal Oswal NASDAQ 100 ETF. 

The core motivation behind this smallcase was the mix of geography. In India, investing in international markets is considered to be an unachievable task,  mainly due to the inefficient cost structure. The general norm is that it is only accessible to a select few with deep pockets. However, that is not the case. Taking exposure to multiple markets (across geographies) drastically increases the odds of better returns. To top it up, the ETF route makes it economically viable for any strata of investors to park money. Previously, we have discussed the concept of diversification and its importance to avoid exigencies. Though the argument could be that it’s essentially the same asset class, geographical development varies to a large extent, especially in the case of a developed and an emerging market, and thus this serves as a good diversification strategy.

Another angle to explore with this smallcase is the presence of both developed and developing markets. As globalization witnesses further paradigm shift, diversification in terms of geography and economic status will turn out to be a significant differentiator. 

The Research team reviews this smallcase on a quarterly basis and manages the weight allocation between the instruments. The smallcase has a fixed allocation model, wherein 50% goes to Indian equities and 50% to International. The smallcase is categorized as Medium Volatility. As mentioned earlier, the smallcase is a cost efficient way to venture into global equities. Global markets, both developed and developing, carry immense value and unlocking it with the help of this smallcase could be a prudent approach. 

End Note

As market participants, we have a tendency to reject things that seem to be extremely simplistic in nature. We like to hold on to our illusion of power, where carrying out something complicated feels fruitful. However, at Windmill Capital, the idea within the team is to always keep things straight forward and effective. The above explanation is a testimony of the simplicity with which we have ideated on all our ETF based smallcases and how we manage them. We shall continue to look for opportunities to broaden our offering universe. ETFs are a smart way to take market exposure and combining the right instruments could yield healthy returns. We firmly believe that this simple concept is a powerful tool to create wealth over the long-term.