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    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.

    Why invest in ETFs?

    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.

    Who should invest in ETFs?

    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.

    Types of ETFs

    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.

    Risks of ETFs

    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.


    How to select ETFs?

    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.

    How to select ETFs?


    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.

    FAQ's

     

    The NAV of an Exchange Traded Funds (the value of the underlying securities held in its portfolio) is calculated after close of market trading hours, by 11pm of each trading day. The NAV is thus determined only once a day. An ETF however is traded on a ‘real-time’ basis, its market price being guided by market prices of underlying securities throughout the trading day.

    The differences between ETF and Index fund are:

    ETF Index Fund
    How are they traded? Traded like shares – can be bought and sold on the exchange at ‘real-time’ prices Traded like mutual fund units – can be invested at NAV determined once every trading day
    How are they priced? Akin to a share - Price is derived basis two factors - the price of constituent securities and the demand and supply of ETFs on the stock market NAV is determined as is in the case of mutual funds
    Frequency of price determination On ‘real-time’ basis Once every day, by 11pm of each trading day
    Costs Higher transactional costs, lower expense ratio No transactional costs, comparatively higher expense ratio
    Need for demat Demat and trading account is a necessity Demat account is not mandatory to invest

    Exchange Traded Funds (ETF) look to mimic the performance of specific index or underlying security. But there may be cases when the ETF falls short in replicating the returns due to ‘tracking error’.
    Tracking Error is defined as the standard deviation of the difference between daily returns of the underlying benchmark and the NAV of the Scheme.

    Tracking error can arise on account of various reasons such as expenses of the fund, liquidity to meet redemption requirements, time taken to re-allocate the portfolio etc.

    Fund managers attempt, at all times, to eliminate or at least minimise this tracking error.

    ETFs offer several benefits to investors; these include access to a diversified portfolio including access to varied asset classes. Being a passive investment instrument, ETFs also come with the benefits of low investing costs and need for low minimums. The stock like trading ease is also a significant benefit. Thus, ETF can be a good investment option.

    How to Invest in Mutual Funds?

    The different types of Exchange Traded Funds (ETF) in India available today are:

    • - Equity ETFs
      Equity ETFs track the performance of stocks constituted in an index. These can be broad based market indices such as the NIFTY 50, BSE Sensex etc.

      1. o Factor ETFs
        Factor ETFs incorporates an investing strategy that consists of focusing on specific return drivers

    • - Debt ETFs
      Debt ETFs track debt instruments such as government bonds and other debt securities, giving investors ETF modelled exposure to fixed income securities.

    • - Gold ETFs
      Gold ETFs track the price performance of gold bullion.

    • - Thematic ETFs
      Thematic ETFs track and mimic thematic or sectoral indices such as NIFTY Bank Index, NIFTY Healthcare Index, NIFTY IT Index, etc.

    • - Global ETFs
      These track and mimic global indices. E.g. – an ETF tracking the NASDAQ-100 Index.

      Also Read - Different Types of Mutual Fund

    You will need a demat account and trading account to invest in ETFs. However for any reason, if you are unable to open a demat and trading account, you have an alternative option to invest in investment products like Index Funds that function similarly to Exchange Traded Funds. Index funds also track a particular index but they are not listed on the exchange. Their purchase and redemption process is similar to any other mutual fund scheme. However, the expense ratio of index funds is more than Exchange Traded Funds.

    The NAV of an Exchange Traded Funds (the value of the underlying securities held in its portfolio) is calculated after the close of market trading hours, by 11 pm of each trading day. The NAV is thus determined only once a day. An ETF however is traded on a ‘real-time’ basis, its market price being guided by market prices of underlying securities throughout the trading day.

    ETFs can be managed either actively or passively by fund managers, but the majority of them are passive investments designed to replicate the performance of an index. The fund manager of an ETF does not apply his expertise to pick and choose ETFs. In actively managed mutual funds, fund managers actively invest in securities based on their analysis and market outlook.

    The differences between ETF and Index funds are:

    ETF

    Index Fund

    How are they traded?

    Traded like shares – can be bought and sold on the exchange at ‘real-time’ prices

    Traded like mutual fund units – can be invested at NAV determined once every trading day

    How are they priced?

    Akin to a share - Price is derived basis two factors - the price of constituent securities and the demand and supply of ETFs on the stock market

    NAV is determined as is in the case of mutual funds

    Frequency of price determination

    On a ‘real-time’ basis

    Once every day, by 11 pm of each trading day

    Costs

    Higher transactional costs, lower expense ratio

    No transactional costs, comparatively higher expense ratio

    Need for demat

    Demat and trading account is a necessity

    Demat account is not mandatory to invest

    For Equity ETFs

    - Long Term Capital Gains: When equity ETFs are held for a duration exceeding one year, the gains arising from them are treated as long-term capital gains and are taxed at 10%. In a financial year, gains of up to Rs. 1 Lakh are exempt from taxes.

    - Short Term Capital Gains: When equity ETFs are held for a duration of less than one year, the gains arising from them are treated as short-term capital gains and are taxed at 15%.

    For Gold, Debt and other ETFs

    Pursuant to amendment to the Finance Bill 2023, any capital gains earned on investments made in these type of ETFs on or after 1 April 2023, will be considered as short-term capital gains and added to the investor’s income and taxed at the applicable income tax slab rates (plus any applicable surcharge and cess), regardless of the investment holding period.

    Please note that investments made on or before March 31, 2023, and held for more than 36 months will be eligible for indexation benefit in taxation. Gains on such investments will be taxed at a rate of 20% (plus applicable surcharge and cess) after taking into account the indexation benefit.

    List of Funds in ETF

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