Exchange Traded Funds(ETFs) – Meaning, Types, Benefits & How to Invest in 2022
As a mutual fund investor, you can invest in either actively managed or passively managed funds. With time, fund managers across the globe are finding it increasingly difficult to beat the benchmark. Hence, these days, more and more investors prefer to invest in passively managed funds. You can invest in passive funds either through index mutual funds or Exchange Traded Funds (ETFs). In this article, we will understand what are ETFs & how to invest in them.
What are ETFs?
An Exchange Traded Fund (ETF) is a security or collection of various securities that tracks an index, commodity, bonds, or a blend of these. For example:
- An Index ETF tracks the performance of an index like the Nifty 50 or Sensex 30
- A Gold ETF tracks the performance of the physical gold price
- A Bond ETF tracks the performance of bonds, etc.
When you buy a unit of an Index ETF unit, you are indirectly buying the underlying index components like shares that are a part of the Nifty 50 or Sensex 30. Similarly, when you buy a unit of a Gold ETF, you are indirectly buying 1 unit of the underlying gold, which can be 1 gram.
How does an ETF work?
An ETF tries to mirror/replicate the performance of its underlying index or securities. For example,
- A Nifty 50 ETF will mirror the performance of the Nifty 50 Index
- A Banking ETF will mirror the performance of the Nifty Bank Index
- A Gold ETF will mirror the performance of the price of physical gold
AMCs launch ETF NFOs (New Fund Offerings) like the NFO of any other mutual fund scheme. An investor can apply in the NFO. Once the NFO closes, the units of the ETF are listed on an exchange like the NSE and BSE. The units are then traded in the secondary market, just like shares.
How to invest in an ETF?
To invest in an ETF, you need a demat account. You can open a trading and demat account with your stockbroker. You can invest in an ETF either at the time of NFO or post-listing; you can buy them from the secondary market. Once the units are listed, you can buy and sell ETF units on the stock exchange (NSE or BSE) through your trading and demat account. Your profits or losses from ETF units will depend on the price you bought and sold your ETF units.
Types of ETFs available in India
Various types of ETFs are available for investment in India. Some of these include:
- Index ETFs: These ETFs have a broad index as their underlying. Some of these underlying indices include Nifty 50, Sensex 30, Nifty Next 50, Nifty Midcap 100, etc. Some examples of index ETFs include:
|Edelweiss Exchange Traded Scheme - NIFTY||NIFTYEES||NIFTY 50 Index|
|SBI ETF NIFTY Junior||SETFNIFJR||NIFTY Next 50|
|ICICI Prudential CNX 100 ETF||ICNX100||NIFTY 100|
|MOSt Shares M100||M100||NIFTY Midcap 100|
|UTI Sensex ETF||UTISENSETF||S&P BSE Sensex|
- Sectoral and thematic ETFs: These ETFs have a sectoral or thematic index as their underlying. Some examples of these ETFs include:
|Kotak Banking ETF||KOTAKBKETF||NIFTY Bank|
|CPSE ETF||CPSEETF||NIFTY CPSE Index|
|Reliance ETF Consumption||RELCONS||NIFTY India Consumption|
|BHARAT 22 ETF||BHARATIWIN||S&P BSE BHARAT 22 index|
|Reliance ETF Dividend Opportunities||RELDIVOPP||NIFTY Dividend Opportunities 50|
- International ETFs: These ETFs track indices in international markets. An investor looking to diversify beyond India can invest in these ETFs. Some examples of these ETFs include:
|MOSt Shares NASDAQ 100||N100||Nasdaq 100|
|Reliance ETF Hang Seng BeES||HNGSNGBEES||HangSeng|
- Debt ETFs: These ETFs have a debt index or debt securities as their underlying. Some examples of these ETFs include:
|LIC Nomura MF G-Sec Long Term ETF||LICNMFET||Nifty 8-13 year G-Sec Index|
|Reliance ETF Liquid BeES||LIQUIDBEES||NIFTY 1 D rate Index|
|Reliance ETF Long Term Gilt||RRSLGETF||NIFTY 4-8 year G-Sec Index|
- Gold ETFs: These ETFs have gold as their underlying. Some examples of these ETFs include:
|Axis Gold ETF||AXISGOLD||Gold|
|Birla Sun Life Gold ETF||BSLGOLDETF||Gold|
|Canara Robeco Gold ETF||CANGOLD||Gold|
|HDFC Gold Exchange Traded Fund||HDFCMFGETF||Gold|
|IDBI Gold ETF||IDBIGOLD||Gold|
Benefits and limitations of investing in ETFs
Some of the benefits of investing in ETFs include:
- Real-time price discovery: There is real-time price discovery in ETFs, just like it happens for share trading. The price of an ETF unit depends on the demand supply and liquidity. Due to this, the price of an ETF unit may be at a premium or discount to the actual NAV.
- No exit load: You can sell your ETF units whenever you want without any specified holding period. There is no exit load in the case of ETFs.
- Liquidity: ETFs can be bought and sold on stock exchanges at any time of day, however, some funds are more popular than others. The easier it is to find a willing seller or buyer for a fund that is traded on a regular basis.
- Lower Costs: Traditional mutual funds have substantially higher expense ratios than ETFs. Because ETF shareholders are not required to pay for the team of managers, analysts, and brokers that trade funds on their behalf or manage the fund's inflows and outflows, this is the case.Transparency: Unlike mutual funds, which are only required to report their holdings every three months, ETFs are required to reveal their holdings and NAV on a daily basis for both open-ended and closed-ended schemes.
- Diversification: Investors can diversify their portfolios across horizontals such as industries, sectors, styles, and nations using ETFs. ETFs can be found in almost every major asset class, currency, and commodity on the planet.
Some of the limitations of ETFs include:
- Brokerage Fees: As ETFs are exchanged like stocks, there are a number of costs associated with purchasing them. The fund managers are usually in charge of this, and they charge a small commission fee for such transactions.
- Requirement of a Demat account: You need a trading and a Demat account for buying and selling ETF units. When you buy ETF units at the time of settlement, they are credited to your Demat account. When you sell ETF units at the time of settlement, they are debited from your Demat account. Opening and maintaining a Demat account entails charges. Also, every time you buy or sell ETF units, you have to pay brokerage and other levies.
- SIP mode of investment is not available: For investing in ETFs, the systematic investment plan (SIP) option is not available. So, every time you want to invest in ETFs, you need to place an order from your trading account.
- Liquidity: In the case of some ETFs units, at the time of selling them, you may or may not find a buyer. Even if a buyer is available, you may not get the price that you are looking for. Hence, liquidity can be an issue in ETFs.
- Stock Market Volatility: Companies that are listed on a stock exchange are exposed to market price changes. They aren't as secure as government bonds. The stock market conditions have a big impact on whether you make money or lose money.
- Diversification: Exchange traded funds have moderate diversity. As most ETFs are passively managed, they generally invest in best-performing companies listed on a particular stock exchange. ETF organisations often overlook small scale companies with huge potential.
How much have Indians invested in ETFs
ETFs have seen a massive rise in India in the last few years. Many people are realising that in case of a lot of active mutual fund schemes, specifically the large-cap schemes, the fund managers are not able to beat the benchmark. Hence, investors increasingly prefer to invest in index mutual funds or ETFs.
Table: AUM of ETFs as of June 2021
|Scheme name||Number of schemes||Number of folios||AUM (Rs. crores)|
In the last few years, a lot of AMCs have launched new and innovative ETF schemes.
Allocate a portion of your portfolio to ETFs
As an investor, you should follow appropriate asset allocation based on your risk profile. You may allocate a small portion of your investment portfolio to ETFs based on your financial planning needs. To plan and systematically invest towards your financial goals, you can partner with Glide Invest. You will get guidance for:
- A personalised risk profile assessment
- Identifying your financial goals
- Appropriate asset allocation
- Making a financial plan for each goal
- Automating the financial plan
- Review and analysis of your financial plan
- Hand holding you till your financial goals are achieved
Q1: What is an ETF?
A1: Exchange-Traded Funds (ETFs) are index funds that are listed and traded on stock exchanges. They allow investors to acquire broad exposure to whole stock markets in various countries and sectors with relative ease, in real-time, and at a lower cost than many other types of investing.
An ETF is a collection of equities that mimics the makeup of a stock market index, such as the Nifty or the BSE Sensex. The trading value of an ETF is determined by the net asset value of the stocks it represents. Consider it a real-time Mutual Fund that you can buy and sell at varying prices throughout the day.
Q2: Is investing in ETFs good for beginners?
A2: Since ETFs have many advantages, such as low expense ratios, ample liquidity, a wide range of investment options, diversification, and a low investment threshold, exchange traded funds (ETFs) are perfect for new investors.
Q3: Is there any kind of a lock-in period for ETF?
A3: ETFs do not have a minimum holding time, and investors can sell their investments whenever they want. The lock-in period for mutual funds like ELSS (Equity Linked Savings Scheme) is three years. It is not possible to liquidate the investment within this time period.
Q4: What are some of the advantages of ETFs?
A4: ETFs surely have some advantages over the traditional open-end funds running in the race. Trading freedom, portfolio diversification and risk management, lower costs, and tax savings are the four most notable benefits.
Q5: Are there some of the negatives of ETFs?A5: ETFs can be incorporated in most tax-deferred retirement accounts because commissions and management fees are cheap. ETFs that trade often, incurring commissions and costs; ETFs with inadequate diversification; and ETFs related to unknown and/or untested indexes are all on the bad side of the ledger.