What is an ETF?

 

                What is an Exchange Traded Fund (ETF)?

                                                        by Rajeev Pathak

                                                                             image designed on Canva

    Even after several years from the launch of India's first ETF, many investors do not know What is an ETF.   Exchange-Traded Fund or ETF is just another form of a mutual fund and it is also managed by an Asset Management Company (AMC). An ETF invests in underlying security like equity, commodity, currency, bond, and even in the whole Index. ETFs are considered passive investments and as such their operational cost is less. The product is most suitable for those investors who are not very active in day-to-day trading in the market, but still, they want to take benefit of market movements. 

    A simple example is an investor can invest in a lump sum when the markets are corrected heavily or through a Systematic Investment Plan in NIFTY ETF  and just sit pretty to see the Index climbing year after year. This is evident from the following data: 

 Movement of SENSEX  

    In 1980, SENSEX was at 148, in 1991 it was at 1909, in 2001 at 3262, in 2011 was at 15455 and now in 2021 as on 18th June, it closed at 52344. Now one can imagine the price movement of SENSEX ETF or NIFTY ETF as that also moves along with the movement of the underlying Index. 

Benefits of an ETF:

    There are many benefits of ETFs which are explained in the following paragraphs:

1.      Low Cost:

    Being a Passive Fund, fund-managers are not required to do daily buy or sell operations in ETFs and thus save on operational costs like brokerage, taxes, etc.  They have just to maintain a pre-decided investment ratio of its underlying security. Whenever Index undergoes a change in its constituents, the fund manager has to do the balancing exercise.

2.      Liquidity:

    An ETF provides liquidity to its investors. ETFs are listed on Stock Exchanges. An investor can buy and sell ETFs just like any other stock.  

3.      Simplicity:

    Investment in an ETF does not require much expertise in stock markets. Just believe in your underlying security be it Gold or Index or Bond and invest in the respective ETF. It is simple because even a layman knows that prices of Gold and Stocks will go up in the long term. So he need not do any research. For example, if an investor wants to invest in a particular company’s stock, he has to do a lot of research. Instead, he or she can simply invest in NIFTY or SENSEX ETF which is a bouquet of stocks.

4.      Affordability:

    ETFs are affordable. If someone wants to buy 10 gms of Gold, he has to spend around Rs.50,000/- or even to buy only one gram of gold, he has to shell out about Rs.5,000/-. On the other hand, he or she can buy a unit of  Gold ETF  for a few hundred rupees.

    We can take another example of NIFTY ETF. If one desires to buy all the stocks of NIFTY 50, he has to invest about Rs.10 lakh to buy the same. But, through ETF he can invest with a few hundred rupees only and have a fraction of holding in all NIFTY 50 stocks.

5.      Transparency:

    Operations in ETFs are considered to be transparent as Funds are required to disclose and publish their holding of stocks on daily basis.

6.      Diversification:

    Investment in an ETF particularly INDEX ETF is considered to be a well-diversified investment. As investment is made in not a particular company or in a particular sector, but in a bunch of companies belonging to different sectors, so an investor can prevent Portfolio or Concentration Risk. Of course, this is not fully applicable to Sectorial Index ETFs or commodity ETFs like Gold, etc.

Type of Exchange Traded Funds (ETFs):

    In India, though ETFs are available in equity, commodity, and  bonds segment, following type of ETFs are most popular for investment. 

1. Equity ETF:

    Most popular in this category are NIFTY ETF. Almost all Asset Management Companies have launched their Nifty or SENSEX ETFs. Other than this certain PSE (Public Sector Enterprises) ETFs are also there. Nifty Junior or Nifty Next 50 Stocks ETFs are also popular in this segment. Total number of ETFs in Equity is around 80. But one has to be careful while investing as all ETFs are not traded frequently or traded with low volume. So, one should observe the liquidity in that particular company’s ETF before investing. Traditionally, NIFTYBees (by Nippon India AMC) has been the most popular Nifty ETF.

2.Commodity ETF:

    In commodities, the most active ETF is Gold ETF, about a dozen AMCs have launched their own gold ETF, but GoldBees ( currently managed by Nippon India AMC) is the most  popular and highly traded.

Who should invest in ETF:

    ETFs are best for those investors who do not have time to watch the stock market on daily basis.

    New investors, students, and women-investors whether working or household may also consider this product as it does not require much research before investment.

    Parents who wish to plan for their children’s marriage can invest in Gold ETF. Its benefit is low cost, no need to worry about its security or paying locker rent, or making charges. Once the marriage is fixed, they can sell the ETF at the then prevailing market price (which is generally near to the market price of Gold), and buy physical gold for making jewelry.  

How to invest in ETF:

    To invest in an ETF, you have to open a Demat Account, if you have not opened it so far. To buy just call your Stock Broker, he will place the order on your behalf. You can also do it yourself if you have an online investment and trading account. In addition, Mutual Fund Distributors can also facilitate your purchase, the only difference is from the stock exchange, you will buy at the current market rate at that moment while through Mutual Fund Distributors, you will buy at the closing price of that day. 

    How you like this post or if you have any queries, please write in the Comment Box. 

The author may be reached at:

boirajeev@gmail.com