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What is Exchange-traded funds (ETFs)?

What are Exchange-traded funds (ETFs)?

Published on 14 December 2021 .Views 5 .Comments 0
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1. Introduction

In recent times, Exchange-traded funds (ETFs) have achieve a board acceptance as financial instruments whose exclusive advantages over mutual funds have captured the eye of many an investor.

2. Meaning Of ETF

ETF stands for Exchange-traded fund. An ETF is much like a mutual fund in that it's really a "basket" of many stocks and other investment assets mixed into a sole investment product. They can only be build by huge financial management institutions, partly due to Securities and Exchange Commission (SEC) rules and partly because only large firms have the assets necessary to put an ETF together.

3. Key Features of ETF

  1. These are a type of investment funds that tracks an index, a commodity, bonds or basket of assets.
  2. The ETFs trading value is based on the net asset value of the underlying assets that it represents. Think of it as a Mutual Fund that you can buy and sell in real-time at a price that changes throughout the day.
  3. ETFs typically have higher daily liquidity and lower fees than mutual funds, making them an attractive alternative for individual investors.
  4. In some sense the ETF is like a stock, as they are traded on the exchange on real-time basis, and thus needs a demat account for trade. In another sense, they work like Mutual funds as the underlying asset comprises of a set of stock/assets.

4. How ETF Works?

  1. First AMC set up idea of ETF and then take permission from SEBI.
  2. Creates basic units for initial investor through NFO
  3. Get listed on any Stock Exchange
  4. Retail Investors start buying & Selling it through Stock Exchange
For Example: Goldman Sachs Gold Exchange Traded Scheme, SBI Sensex ETF

5. Types of ETF

  1. Index ETF: Oldest and most common type of ETFs today. They acquire stocks/shares in amounts that proportionately reflect an existing stock index. Goal of the fund is to emulate the index it reflects and not outperform it. For Example: ICICI Prudential Nifty ETF reflects Nifty 50 Index
  2. Commodity ETF: These ETFs invest in commodities such as Gold, Silver etc. Currently, only Gold ETFs are available in India. Prices of Gold ETFs move hand in hand with Physical Gold. For Example: Reliance ETF Gold Bees
  3. Bond ETF: These ETFs invest in bonds. When the stock market shows its downward swing, these ETFs are in demand.For Example: LIC MF G-Sec Long-Term ETF which reflects Nifty 8-13 years G-Sec Index
  4. International ETF: These ETFs invest in Foreign index such as MSCI global index, NASDAQ etc.For Example: Motilal Oswal Most Shares NASDAQ 100, which reflects Nasdaq 100 index.

6. Pros & Cons of ETF

ETFs are a kind of Passively managed mutual funds. Just like any other investment vehicle, exchange-traded funds have their own benefits and drawbacks. So, before you invest in them, you need to know their pros and cons and decide if ETFs are the right option for you.

a. Pros of ETF

  1. Lower Cost: Since they are passively managed, major benefit of ETFs is their very low cost structure. Their expense ratios are as low as only 0.07%.
  2. Lower Risk: ETFs follow an index and hence are not dependent on a Fund Manager’s decision making. Therefore, these are one of the least risky Equity funds.
  3. Diversification: ETFs give you instant diversification in all stocks of the underlying Index.
  4. Transparent Portfolio: ETFs have a very transparent portfolio holding and predefined basket creation.
  5. You can time the market: Since ETFs can be traded actively like stocks, there is an option to time the market in case of wide intraday fluctuations.
  6. Can start at very low investments: You can buy as low as 1 unit of ETF, which is typically for a few hundred rupees.
  7. Easy to choose: Since ETFs simply track an index, you just need to finalize the type of index you want to buy.

b. Cons of ETF

  1. Trading costs can be high: Depending on your brokerage plan esp. if you are buying and selling ETF frequently.
  2. Liquidity Risk: Especially in Index ETFs, liquidity can be a risk as they are still not very popular in India. Still there are days when no trading happens in few of ETFs.
  3. Limited Options in India: In developed Financial Markets, there is a wide variety of ETFs available such as – Currency ETF, Sector specific ETF, Active Managed ETF etc. which are not available in India

You need to have a Demat account to buy ETFs, you cannot buy them from your mutual fund account.

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