A Guide to Exchange Traded Funds

Mutual Fund India allows Indian investors to invest in two kinds of mutual funds. They are actively managed mutual fund schemes and passive funds. Exchange Traded Funds or ETFs are known as passively managed mutual funds.

When diving into mutual fund investment, exchange-traded funds, or ETFs commonly referred to, emerge as a good choice because of their simplicity and low expenses. Their popularity in the asset management ecosystem in India is growing rapidly, as per the data from AMFI in July 2023, which highlighted that the total ETF AUM (including Gold ETF) reached a staggering Rs 5.7 lakh crores, accounting for nearly 75% of the total passively managed mutual fund investments asset under management (AUM).

What Exactly is an ETF?

An exchange-traded fund is a type of security that mirrors the performance of an index, a specific commodity, a bond, or a collection of various assets akin to an index fund. When you invest in ETFs, such as the Nifty 50 or BSE Sensex, you’re purchasing a piece of a portfolio that reflects the selected index. Unlike traditional mutual funds, ETFs don’t aim to surpass the returns of the referenced index; instead, they aim to replicate the returns of it.

ETFs work like regular stocks on stock exchanges, with their prices fluctuating in real time based on buying and selling activity. Therefore, by design, they offer greater liquidity throughout the trading day.

Exchange traded fund schemes generally come with reduced fees compared to active mutual funds, making them a preferred choice for cost-conscious investors.

Types of Exchange-Traded Funds –

  • Stock-Market ETFs: These are the most common ETFs and track a particular broad market index, such as the S&P BSE Sensex or the Nifty 50.
  • Bond ETFs: These ETFs invest in bonds, aiming to provide exposure to the bond market’s different sectors, be it corporate, PSU bonds, or gilts.
  • Commodity ETFs: These are designed to track a single commodity like gold, Silver, or a basket of commodities.
  • Sector and Industry ETFs: These provide targeted exposure to specific sectors of the economy, like technology, healthcare, finance, or banking.
  • International ETFs: International ETFs focus on markets outside India, like the Nasdaq 100 or the S&P 500.

Benefits of Investing in ETFs

You will find many benefits while investing in ETFs –

  1. The first is ‘diversification’. Since ETFs hold a basket of securities, they offer diversification by design, thus reducing the risk associated with owning individual securities, which can be equity or bonds.
  2. The second is ‘liquidity,’ as units of ETF can be bought or sold throughout the day at market prices during trading hours.
  3. And the third is the ‘low cost.’ The ETFs have lower expense ratios than traditional mutual funds, which are actively managed. Since the ETF fund manager tries to replicate an index portfolio, the effort and cost of creating the portfolio are much less.
  4. Transparency is the fourth benefit, as ETFs disclose their holdings daily; thus, the investors always know what assets are held in the ETF portfolio.

How to Invest in ETFs in India?

If you wish to invest in exchange-traded funds, you must have a demat account and stock trading account with a broker, as ETF units are available in demat form only. You can buy and sell units of exchange-traded funds during trading hours, just like you’d purchase a stock.