Exchange Traded Funds (ETF)

Exchange Traded Funds or ETFs are funds that trade on an exchange, just like a stock. They replicate the portfolio and performance of a publically available Index such as BSE Sensex, NIFTY 50, NIFTY Bank, etc. This means, when you are buying units of an ETF, you are acquiring a stake in a portfolio designed to mirror the performance and yield of its underlying index.

ETFs have several advantages over traditional open-ended funds. The most prominent benefits of investing in ETFs are:

• Portfolio diversification and risk management

  The biggest reason to invest in ETFs is that it allows you to diversify your portfolio across horizontals such as industries, sectors, styles, or countries, giving you broader investment exposure. Besides, you can trade them on almost every asset class, commodity and currency in the world. This enables better risk management.




• Performance focused

  ETFs are focused on index strategies to replicate their performance. By default when an index eliminates or reduces the weight of underperformers in their index portfolio, the same will be replicated by ETFs in their portfolio thus minimizing the impact of underperforming companies in their portfolio.




• Simplicity

  One of the important benefits of ETFs in comparison to actively managed funds is that ETF mutual funds offer a lot of investment simplicity. You do not have to pay attention to otherwise critical factors such as understanding the fund manager’s investment style, analysing past performance, assessing how the fund has historically performed in the bull and bear market phases, etc. Typically, ETFs track large-cap indices. All you have to do is choose an index and invest in an ETF that tracks that index. That’s it and you are good to go!




• Low cost

  ETFs typically have significantly lower expense ratios compared to other schemes of mutual funds. While ETFs can have expense ratios as low as 0.25%, mutual funds usually have expense ratios ranging from 1.5% to 2.25%. The reason for this difference is that ETF unit holders are not required to cover the costs of a team of managers, analysts, and brokers to handle the fund's trading or manage the flow of money in and out of the fund.

ETF mutual fund is a great investment option. However, choosing the right ETF requires a thorough understanding of the financial market.

They are ideal for investors looking to take exposure in equity and have long-term goals like wealth creation at a very low cost. ETFs could help investors participate in equity without any bias of the fund manager’s track record or experience as this gives a broad exposure to a particular index.

ETFs could also be used for diversifying one’s portfolio across indexes with exposure to only systematic risk. They provide access to various investment options such as investing in commodities, foreign indices, and international securities. Investors having a Demat Account looking to invest lumpsum amount in equities could use ETFs for the most simplistic way of taking exposure in the asset class.

Some of the popular types of ETFs are as follows:

Index ETFs

Index ETFs track a specific index. They enable investors to gain exposure to the entire index through a single trade.

Commodity ETFs

Commodity ETFs track the performance of a particular commodity such as gold, silver, natural gas, oil, etc. They enable investors to gain exposure to the commodities without having to purchase futures contracts.

Currency ETFs

Currency ETFs track the performance of a particular currency or a basket of currencies. They enable investors to participate in currency market transactions without purchasing a specific currency.

Bond ETFs

Bond ETFs track the performance of different types of bonds such as government bonds, corporate bonds, municipal bonds, etc. They enable investors to gain exposure to a variety of bonds without having to purchase individual bonds.

Sector ETFs

Sector ETFs track the performance of a specific market sector such as banking, technology, health care, etc. They enable investors to gain exposure to a particular sector without having to purchase individual stocks from that sector.

International ETFs

International ETFs track global markets or a country-specific benchmark index. They enable investors to gain exposure to overseas stocks and bonds.

ETFs have been a preferred investment choice among investors seeking direct exposure to benchmark indices. However, they can sometimes be less advantageous because they offer returns that closely match the returns of the underlying indices. Since ETF fund managers cannot exercise discretion in selecting securities or deviate from the index weightage, investors cannot expect outperformance from their ETF investments. Furthermore, ETFs can exhibit higher volatility than individual stocks due to their composition of multiple assets and susceptibility to market fluctuations. Besides, ETF funds carry more transaction costs compared to individual stocks since they generally have higher buying and selling expenses.

Investors should consider three important factors while selecting an ETF.

Total Expense Ratio

The expense ratio is an annual fee a fund charges to cover its expenses. The lower the expense ratio, the better it is for investors as it indirectly translates to cost savings.

Tracking error

Tracking Error is the difference between the ETF return and its benchmark index return. The tracking error of an ETF is considered low when the difference between these two is less. Low tracking error ensures optimum returns in comparison to index returns.

Liquidity

Liquidity is an important consideration factor when buying ETFs as high liquidity ensures easy buying or selling of ETFs on the stock exchange. High liquidity means there are sufficient trading volumes of the ETF on the exchanges during a trading session making it easy for you to trade in them.

You can invest in exchange traded funds by following these simple steps:

• Open a brokerage account

  Download and install the app on your mobile device or visit the website to log in to your account.

• Select the desired ETF

  Choose the ETF fund you want to invest in by browsing or searching for them.

• Transfer funds

  Transfer money into your brokerage account to buy ETF funds.