Exchange Traded Funds (ETF)

Introduction:

Exchange Traded Fund is a security that tracks an index, a commodity or a sector like an index fund or a sectoral fund but trades like a stock on an exchange. It is similar to a close-ended mutual fund listed on stock exchanges. ETF's experience price changes throughout the day as they are bought and sold.

Exchange Traded Funds (ETFs) have been in existence in India for quite some time now. But so far ETFs have not enjoyed the kind of popularity that the conventional Mutual Funds enjoy. One reason could be the lack of understanding of the concept of ETF amongst the general investor. Second, and probably the more important reason, is that ETFs by nature track a certain index (e.g. SENSEX or the BANKEX). Hence, the returns one can expect from ETFs will be equal to the rise in the index. Whereas, India is a growing market and hence offers huge opportunities in the non-index shares too. Therefore, it is not difficult for an active fund manager to beat the index and offer better returns. As such ETFs (and index-funds too, by that logic) have comparatively negligible AUMs. Two things could, however, make ETFs popular in India

  • One, of course, is that as market valuations become fairly or over-valued, it will become more & more difficult to beat the index. Then index-based funds (both conventional MFs & ETFs) may become a better option than actively-managed funds
  • Gold ETFs or Real-Estate ETFs have no comparable product in the conventional MF sector, and hence become the only MF route to invest in such markets

Major types of ETF in India:

  • Commodity ETF

    : Commodity ETF invests in commodities such as precious metals and futures. In India, we only have Gold ETF
  • Bond ETF

    : In case of Bond ETF’s there is currently only one such ETF available in India, i.e. Liquid BeES.
  • Index ETF

    : Index ETF is actually index funds that hold and keep certain securities and attempt to duplicate the performance of a stock market index. An index fund main objective is to track the performance of an index by holding in its portfolio either a sample of the securities in the index or the contents of the index.

Advantage of ETF:

  • Cost Effectiveness

     – ETFs can be economical to buy and especially cheap to maintain over the long run.
  • Single Transactions

     - ETFs act like indexes and follow certain market sectors. However, unlike an index, you can purchase an ETF with one single transaction.
  • Simplicity

     - ETFs are simple in structure and easy to understand. If you are looking to invest in a certain industry or want to emulate the ROI on a particular index, you are only a trade away from getting started with ETFs.
  • Diversification

     – With a lot of ETFs, especially index ETFs, you can essentially buy a basket of securities in one trade.
  • Passive Management

     - ETFs are meant to follow a particular index, not outperform it. Therefore, only minor adjustments are needed for the ETF, as opposed to an aggressively managed fund. This in turn lowers risk and management fees.

How to Invest in ETF:

To Invest in ETF, all you need to have a demat account and a trading account with an online account for trading stock, that would suffice to invest in ETFs. Pan card, Identity proof and Address proof are required to open demat and trading account.

Once you have got the account ready it’s just a matter of choosing ETF and place the order online from your broker’s trading portal. The orders are routed to the exchange where the purchase order are matched with the sell orders and executed band a confirmation will be sent back to you.