ETF Risks for Large Investors in India: Tracking Error & Liquidity

"Investing ₹50L–₹1Cr in ETFs? Learn how tracking error, low liquidity & NAV disparity can cost big. Smart tips to avoid slippage and protect returns. "



You're absolutely right—ETFs (Exchange Traded Funds) can look great on paper, but real-world performance often differs due to a few crucial issues, especially when large amounts (like ₹50 lakh to ₹1 crore) are involved. Let's break down Tracking Error, Liquidity Issues, Price Discovery, and Disparity in the context of low average daily volume, and how this can severely impact investors with larger capital:

1. Tracking Error

Definition: It’s the difference between the ETF's returns and its benchmark index.

Why it matters:
When you're investing ₹50 lakh or more, a small tracking error of even 1-2% annually can mean a loss of ₹50,000 to ₹1 lakh+ versus the index.

Causes:

  • Fund manager holding cash instead of being fully invested.

  • Expense ratio, rebalancing cost, or delay in replicating index changes.

  • Dividend reinvestment lag.

Example:
If Nifty 50 returns 12% and your ETF gives 10.8%, that 1.2% tracking error means ₹60,000 lost on ₹50 lakh investment.

Also read: Smart ETF investing strategy

2. Liquidity Issues

Definition: Liquidity refers to how easily you can buy/sell the ETF without impacting its price.

Problem with low volume ETFs:

  • Many Indian ETFs have average daily volumes below ₹10–20 lakh, sometimes even ₹1–2 lakh.

  • A ₹50 lakh order can cause a major impact cost, where your order itself moves the price unfavorably.

Impact:

  • Wider bid-ask spreads (you might have to buy at a higher price and sell at a lower price).

  • Partial or delayed execution.

Example:
Let’s say you want to buy ₹1 crore of an ETF with a daily volume of ₹5 lakh. You might end up:

  • Moving the market price up by 1-2%.

  • Facing slippage and ending up with fewer units or higher cost.

3. Price Discovery

Definition: How accurately the ETF price reflects the NAV (Net Asset Value) of underlying securities.

In low-volume ETFs:

  • The market price may not reflect real-time NAV, especially in volatile markets.

  • Often trades at a premium or discount to NAV.

Impact:

  • Your ETF may show a “gap-up” or “gap-down” open, which is not aligned with the index movement.

  • Hard to enter/exit at a fair price during market stress or rapid index movement.

4. Price Disparity (Premium/Discount to NAV)

What happens:

  • ETF market price trades at premium (higher) or discount (lower) than NAV.

  • This happens more in low-volume ETFs where market makers aren’t active.

For large investors:

  • You might end up paying 1-2% more than NAV while buying.

  • And receive 1-2% less than NAV when selling—effectively losing 2–4% roundtrip on large investments.

Example of the Issue in Real World

You want to invest ₹75 lakh in a Midcap ETF with ₹3 lakh daily volume.

  • You place a large order—either your order gets split over several hours, or executed at unfavorable prices.

  • NAV of ETF may be ₹150, but ask price is ₹152. You’re already paying 1.3% extra.

  • Market opens gap-up due to foreign cues, ETF shoots up 2%, but you haven’t entered yet.

  • You sell after a few days, and ETF trades at ₹151 while NAV is ₹152. You lose another 0.6%.

Total potential loss from:

  • Spread/slippage: 1.3%

  • NAV discount on sell: 0.6%

  • Tracking error: 1.2% annualized
    Total impact = ~3% loss or ₹2.25 lakh on ₹75 lakh

Summary for Large Investors (₹50 lakh – ₹1 Cr):

Factor               Impact on Large Investors
Tracking Error                        Annual returns differ from index
Liquidity Issue                       Can’t exit easily; slippage on big orders
Price Discovery                       Market price doesn't match real NAV
Premium/Discount                     Buy high, sell low—inefficient transactions

What You Can Do

  • Stick to high AUM, high volume ETFs (like Nifty 50, Nifty Bank, GoldBees).

  • Use Limit Orders to avoid bad pricing.

  • If investing large capital, consider index mutual funds or create a direct index portfolio.

  • Track tracking error and premium/discount on AMC websites or NSE portal before investing.

FAQ

1. What is tracking error in ETFs and why is it important?

Answer: Tracking error is the difference between an ETF’s returns and its benchmark index. For large investments (₹50L+), even a 1–2% tracking error can lead to significant underperformance, amounting to thousands in lost returns annually.

2. How does low liquidity affect large ETF investors?

Answer: Low liquidity leads to wider bid-ask spreads, higher slippage, and delayed or partial execution of large orders. A ₹50 lakh+ order in a low-volume ETF may move the market price unfavorably by 1–2%.

3. What is price discovery in ETFs?

Answer: Price discovery refers to how accurately an ETF’s market price reflects the NAV of its underlying assets. In low-volume ETFs, prices may deviate from NAV, especially during volatile market hours, leading to unfair entry or exit prices.

4. Why do some ETFs trade at a premium or discount to NAV?

Answer: Low demand or absence of market makers can cause ETFs to trade above (premium) or below (discount) their true NAV. This impacts large investors more, as they may buy high and sell low—losing 2–4% roundtrip.

5. What is the solution for large investors facing ETF inefficiencies?

Answer: Stick to ETFs with high AUM and daily volumes (e.g., Nifty 50, GoldBees). Use limit orders to avoid slippage, and consider index mutual funds or direct stock portfolios for large-scale index investing.

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Here’s a list of high-volume, high-AUM, and relatively low tracking error ETFs in India that are better suited for large investors (₹50 lakh to ₹1 Cr+), along with key metrics like average daily volume, AUM, and tracking error (as per latest available data):

1. Nippon India Nifty BeES (NIFTYBEES)

  • Index: Nifty 50

  • AUM: ₹12,000+ Cr

  • Avg Daily Volume: ₹30–70 Cr

  • Tracking Error: ~0.15%–0.25%

  • Remarks: Highly liquid, ideal for large investments.

2. SBI Nifty 50 ETF

  • Index: Nifty 50

  • AUM: ₹2,800+ Cr

  • Avg Daily Volume: ₹5–10 Cr

  • Tracking Error: ~0.10%–0.20%

  • Remarks: Backed by SBI; good institutional choice.

3. ICICI Prudential Nifty Next 50 ETF (ICICINXT50)

  • Index: Nifty Next 50

  • AUM: ₹3,000+ Cr

  • Avg Daily Volume: ₹2–5 Cr

  • Tracking Error: ~0.35%–0.50%

  • Remarks: Reasonable liquidity; good for partial entry/exit.

4. Kotak Nifty Bank ETF (KOTAKBKETF)

  • Index: Nifty Bank

  • AUM: ₹3,500+ Cr

  • Avg Daily Volume: ₹10–15 Cr

  • Tracking Error: ~0.20%–0.30%

  • Remarks: Good for banking exposure with strong volumes.

5. Motilal Oswal Nasdaq 100 ETF (NASDAQ100)

  • Index: Nasdaq 100 (USD)

  • AUM: ₹2,500+ Cr

  • Avg Daily Volume: ₹3–6 Cr

  • Tracking Error: ~0.50%–0.80%

  • Remarks: Popular for US tech exposure. Use limit orders due to global timing mismatch.

6. Nippon India GoldBeES

  • Asset: Physical Gold (Equivalent to 1 gram/unit)

  • AUM: ₹7,000+ Cr

  • Avg Daily Volume: ₹10–20 Cr

  • Tracking Error: ~0.30%

  • Remarks: Best for gold investing among ETFs.

7. UTI Nifty 50 ETF

  • Index: Nifty 50

  • AUM: ₹2,000+ Cr

  • Avg Daily Volume: ₹2–5 Cr

  • Tracking Error: ~0.10%–0.25%

  • Remarks: Consistent performer; decent liquidity




Location: Ahmedabad, Gujarat, India

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