When I talk about ETFs or an exchange-traded fund, many of you may have familiar with it or unaware about it. It is a vehicle that trades on stock exchanges, just like you trade stocks. It consists of assets or collection of assets like stocks, commodities, or bonds. ETFs are gaining popularity as investments opportunity because of their low costs, tax efficiency, and stock-like features.
They are simple investment products that give you the flexibility of stock investment and the simplicity of equity mutual funds. In India they trade on the NSE cash market like stocks that you can buy and sell conveniently at market prices.
ETF is unlike index fund where you have to acquire index fund units through mutual fund house. It can be bought or sold directly from a secondary market through a commissioned stockbroker. All you need to have a trading account or a Demat account. That’s why they are liquid in nature.
How An ETF Derives:
This is a fund that owns assets or collection of assets such as bonds, stocks, gold and so on and divides the ownership of it into shares that are held by you as shareholders. You indirectly own the assets of the fund and will get a share of the profits or dividends. And in the event of liquidation of the fund, you can get a residual value. You can easily buy and sell their ownership in the open stock market.
The demand and supply equation will influence the price of an ETF. When there is a strong demand for it, its share price will rise above its net asset value per share, giving back you an incentive to purchase additional units and sell the its shares in the open market. Similarly when there is weak demand, its shares trade at a discount from net asset value.
Some of the Popular Types of Exchange Traded Funds
Most exchange traded funds are index funds that strive to repeat the performance of a specific index. Indexes are forms that are based on stocks, bonds, commodities, or currencies. An index fund tries to track the performance of an index. This is a good option to choose because of their liquidity advantage.
The most popular ETFs track stocks. They are composed of large-cap, mid-cap, small-cap, growth, value and so on. For instance, the S&P 500 index contains large-cap and mid-cap stocks. iShares Russell 2000 are mainly for small-cap stocks. Some others are iShares Russell 1000 Growth and iShares Russell 1000 Value.
Some ETFs such as iShares Select Dividend that focus on dividends is popular in the US market. In India, ICICI Prudential Nifty follows Nifty 50 Index or Kotak Banking follows Nifty Bank Index. They can also be available in sector funds like finance and technology. They can be for one country or global specific.
They flourished during economic recessions because investors pull their money out of the stock market and put into government treasury bonds or company bonds. This way you can safeguard your investment to a greater extend and can generate good returns in a time when slow down of economy or short-term recession affect you these days.
Commodity Exchange Traded Fund
They invest in commodities like precious metals, agricultural products, or hydrocarbons. Among the first commodity, exchange traded fund were gold exchange-traded funds or gold eft that have been offered in a number of countries. ETF gold is very popular worldwide.
Currency Exchange Traded Funds
Rydex Investments launched the Euro Currency Trust in 2005. In 2007 Deutsche Bank‘s DB x-trackers launched EONIA Total Return Index ETF in Frankfurt tracking the euro. I don’t think they are the right option to look for investment. The currency market is hugely dominated by algorithmic trading and is very volatile in nature.
Actively Managed Exchange Traded Funds
Most exchange traded funds are passively managed index funds, but some do have an active management policy. Actively managed exchange traded fund grew faster in their post-existence periods than the index ETFs did. As the productive track records came out, many see actively managed have shown a notable competitive threat to actively managed mutual funds.
Leveraged Exchange Traded Fund
Those are a kind that thrive to achieve returns that are more productive to market movements than non-leveraged ones. They are often bull or bear funds. A leveraged bull fund might be ventured to achieve daily returns that are 2x or 3x more than the Dow Jones Industrial Average or the S&P 500. A leveraged inverse bear ETF fund may strive to achieve returns that are -2x or -3x the daily index return, meaning that it will gain double or triple during the market crash.
An ETF is a collection of stocks or assets under a brand name. The fund automatically performs depending on the performance of its underlying index. It enjoys lower expense ratios compared to MF. However, frequent trading of ETFs can lose you money due to higher brokerage charges. For Investing in ETF or redemption of it, all you need to have is a trading account or Demat account for Indians.
ETF units or shares are traded real-time on an offer/bid price during market hours and is driven by demand & supply. So, price of its unit of underlying securities could deviate higher or lower around a value known as the fund’s net asset value (NAV). They often have lower expense ratios than index funds. Hence, ETFs can provide a slighter edge in returns over index funds.
With the arrival of discount brokers across the world like Robinhood in the US market, Zerodha in India, the trading costs reduced drastically. The fees for ETF are much lower compared to MF/Index Fund. Expense ratio of ETF stocks hover around 0.05% to 0.17% and around 0.25%-0.67% for bond/debt ETFs. The expense ratio of Gold and Global Indices is slightly higher.
A mutual fund, on the other hand, is a collection of stocks grouped together under a brand name and generally sell to investing public through commissioned brokers. MFs are chiefly open-ended and close-ended. Close-ended MF can trade on a stock exchange. Mutual funds are actively managed by fund managers and hence fund manager’s efficiency and performance is very crucial in producing market expected returns. You will be able to buy and sell the MF units at the end of the day exactly at its NAV.
An index fund is like a mutual fund that is managed by an Asset Management Company (AMC). Both ETF and Index Fund are passively managed financial products. You can redeem units through AMC directly with a valid bank account.
What are the Popular ETFs in India?
In India, the ETF market is not that developed and popular among investors. Still you can find many of them in India that spread over GOLD, NIFTY, MIDCAP, LARGECAP, SENSEX, BHARAT 22 or BANK NIFTY, CPSE and so on.
You’ll find ICICI Prudential Nifty and Kotak Banking ETFs (equity-based). You’ll also come across the efts of LIC Nomura MF G-Sec Long-term, Reliance Liquid Fund Dividend Reinvestment and DSP Blackrock Liquid Fund Dividend Reinvestment. ETF Gold such as Axis Gold and Kotak Gold are also available. Besides, you can trade one global index-based ETF like Reliance Hang Sang BeES.
What are the Better Strategies for Investing in ETFs?
If you’re familiar with stock investing, then you are ahead to devise a good strategy. Working out and executing strategies is a lot of hard work, that you should not be worried about. Fortunately your asset manager will handle those all.
Your job is to save what you can and keep it invested in a systematic and disciplinary manner. Never waste your time trading in a haphazard way. Rather than spend your time picking good stocks or ETFs. In this way, you’re better off developing a portfolio that blends various strategies keeping in mind your risk tolerance.
Which is Better: A Stock or an S&P 500 Index ETF?
The S&P 500 ETF is limited to the S&P arena and tracks that specific market that historically generated a very good return earlier. Incidentally, there are some ETFs that track just about any market. And if you were in at the right time, they would have beaten the S&P ETF. The iShares Thailand Capped would have given you 38% Vs the Vanguard S&P 500’s 16%.
How Good it is to invest in Gold ETF
ETF gold has gained a lot of significance over the last decade. They first came into existence in 2003 in Australia. Since then Gold ETF spread over the large part of the world market. The first Gold ETF in India was the Gold BeES that launched in 2007.
Ironically, these days you can buy gold ETFs online or on stock exchanges and keep them in your Demat Account. Gold ETFs are units in lieu of physical gold, that often available in de-materialized form or paper form. One gold ETF unit is equal to one gram of gold and is backed by physical gold of very high purity.
Advantages of Exchange Traded Fund:
They generally render easy diversification, low expense ratios, and tax efficiency of index funds that behave like an ordinary stock. You can acquire them economically, held, and disposed of. That’s why some investors treat its shares as a long-term investment for asset allocation purposes. Some institutional investors trade ETF shares frequently to hedge their risk over short periods or timing the market. It has several advantages listed below:
- Low costs: They generally have lower costs compared to other investment products. They typically have lower marketing, distribution and accounting expenses. You’ll have to spend less fund management fees.
- The Flexibility of Buying and selling: Unlike mutual fund, you can easily buy and sell them at current market prices at any time during the trading day. You can buy ETF shares on margin and sell short, enabling you to implement the hedging strategies. It renders you to use stop orders and limit orders that allow you to specify the price points at which you are willing to trade.
- Tax Efficiency: They generally produce comparatively low capital gains because they typically have low turnover. If you do not redeem, their tax efficiency will further enhance.
- Market Exposure and Diversification: It bestow you on an economical way to re-balance portfolio allocations and to equitize cash. An index ETF typically delivers diversification across an entire index. If you invest in one unit, your risk will spread over all underlying securities. They offer exposure to a diverse variety of markets such as broad-based indices, industry sector-specific indices, bond indices, and commodities.
- Liquidity: As you’re able to trade them like a stocks on real-time basis during market hours, you can find it with higher liquidity.
- Timing the Market: If you’re a seasoned investor, you can time the market. If you’re a chart follower,it’ll give you an added advantage. What I mean here is that in a short bear market after the desired correction, you can buy at a major support level or sell it at a major resistance level.
What are the Disadvantages of ETF?
- They can generate lower returns than actively managed funds. Several actively managed funds out there in the market are able to beat their own indices in large instances.
- Frequent transactions cost you more due to involvement of brokerage.
- Being less popular in India, there may be some sort of liquidity problem. Some remain non-traded for several days. As popularity increases, the liquidity issue tends to reduce.
- There is a myriad variety of them for Equity, Commodity, Sector-specific that available in developed countries which lack in India.
- In developed market, actively managed fund managers have a lesser opportunity available to beat indices. That’s why they are more popular in developed economies where you can enjoy similar returns than index funds with lower fund management fees. With increasing popularity, the fund management cost tends to reduce as compared to Indian market. Unless Indian exchange traded fund market develops, the actively managed funds could beat indices and generate more return than ETFs.
If you just start investing in the stock market and lack nitty-gritty of stock investing or don’t have time to research into the fundamental or technical studies of stocks, then you can try them for your newfound options. If you do a little bit of research on ETF, you’ll find them with growing popularity among investors. But it also has its inherent drawbacks. And with utmost care in your selection process, you’ll be able to steer you away from potential pitfalls.
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