The Indian investment landscape has undergone a remarkable transformation in recent decades. Investors are shifting their investments from traditional investment avenues such as bank fixed deposits and recurring deposits to different investment vehicles like mutual funds, and exchange-traded funds (ETFs) among others.
But, What are ETFs?
ETFs are portfolios of securities traded on stock exchanges, offering investors a blend of diversification similar to mutual funds and the liquidity characteristic of stock trading.
On a global scale, ETFs are a prevalent form of passive investment, and in India, ETF investing is gradually gaining traction.
The process involves fund AMC inviting institutional subscriptions tied to indices like the Nifty, subsequently converting these subscriptions into smaller units accessible to retail investors for trading on stock exchanges.
In this blog post, let’s explore the fundamentals of ETFs tailored for beginners who have numerous questions and are continuously seeking answers online.
Understanding ETFs: What Sets Them Apart from Mutual Funds?
An ETF, or exchange-traded fund, stands out from typical mutual funds in a couple of ways. Like all mutual funds, it pools money from investors and has a fund manager overseeing things, including the calculation of its NAV (net asset value).
However, two distinct features set ETFs apart:
Stock Exchange Trading
Unlike regular mutual funds, ETFs are actively traded on the stock exchange.
Passive Approach
ETFs take a passive approach by tracking benchmark indices such as Nifty or Sensex. The fund managers ensure that the ETF’s returns closely align with those of the chosen index.
Similar to stocks, ETFs are listed on stock exchanges. Investors have the flexibility to invest in them or trade them through their stockbrokers.
Key Differences Between ETFs and Index Funds
The main differences between ETFs and Index funds are:
Flexibility
ETFs allow buying and selling at any time during the trading day at the current market prices, whereas index funds establish their price once, usually at the closing market price.
Intraday Advantage
ETFs facilitate intraday trading, allowing investors to seize opportunities from price fluctuations within the trading day, a feature absent in index funds.
Redemption Rules
Index funds only let you redeem through the fund house at the closing NAV. But with ETFs, you can buy and sell on the secondary market at current prices.
Types of ETFs
Here are the different types of ETFs:
- Equity ETFs
- Gold ETFs
- ETFs with International Exposure
- Debt ETFs
What Can These ETF Types Offer?
- Equity ETFs and Sector Tracking
These ETFs aim to mirror the performance of stock indexes or specific industries. Their goal is to replicate the benchmark index or a particular sector’s performance.
- Gold ETFs for Portfolio Diversification
Gold ETFs invest in gold bullion, offering a way to include gold in a portfolio without owning physical gold. This strategy helps mitigate currency volatility and economic downturns.
- International Exposure through ETFs
Some ETFs replicate returns from foreign stock indexes, providing investors access to overseas markets and the growth stories of specific economies.
- Debt ETFs for Fixed-Income Assets
Debt ETFs offer the opportunity to invest in fixed-income assets. They are actively traded on the NSE and are a more cost-effective option compared to debt mutual funds.
Selecting Your Ideal ETF
When choosing an ETF, consider these key factors:
Understanding ETF Categories
Explore diverse categories—equity, gold, international exposure, and debt. Each category contains sub-divisions, offering various investment avenues.
Evaluating Trading Volume
While most ETFs now boast good liquidity, some underlying stocks might face challenges with lower trading volumes. Prioritize ETFs with robust trading volumes for hassle-free transactions.
Consider Expense Ratio Impact
Be mindful of expense ratios, as they can significantly impact your returns. Opt for an ETF with a lower expense ratio compared to its counterparts to maximize potential returns.
Analyze Tracking Errors
ETFs aim to mirror specific indices, but variations in returns, termed tracking errors, are common. When selecting an ETF, aim for one with minimal tracking errors to align more closely with its intended index.
Conclusion
Over the past years, Indian investors have moved from conventional investments to ETFs, which combine diversification with stock trading liquidity. ETFs differ from mutual funds and index funds, and track indices like Nifty while offering flexibility and various types for investment suitability.
Before investing blindly and hoping for better returns, it’s crucial to grasp the fundamentals of ETFs. Pick ETFs that best suit your financial goals.
FAQs
- What do popular Indian ETFs track?
In India, the most popular ETFs follow indexes such as the Nifty 50, Sensex, Nifty Bank, gold rates, and government securities. You’ll also find sector-specific and thematic ETFs focusing on areas like IT, pharma, and more.
- What are the advantages of investing in ETFs?
ETFs offer diversification, flexibility in trading, lower expense ratios, transparency, and access to various markets or sectors.
- Are ETFs suitable for long-term investments?
Yes, ETFs can be suitable for long-term investment strategies due to their diversification benefits and potential for growth over time.