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  • Writer's pictureSahastha

Exchange-traded fund (ETF)

Updated: Oct 4, 2023

Exchange-traded fund (ETF) is kind of an index fund that invests in an index, a commodity, currencies, bonds etc. ETF is a portfolio of securities traded on a  stock exchange which are part of a predetermined index.  ETFs were first created in the early 1990s as a way to provide access to passive, indexed funds to individual investors. After nearly a decade, first ETF ( Nifty ETF Fund / Nifty BeEs) launched by Benchmark Mutual Fund. This ETF tracked the performance of the Nifty 50 Index. ETFs will impact the financial services markets more broadly than in the past.

Over the last few decades, investors have confidently moved from the traditional investment instruments to the more evolved options like exchange traded funds. Around the world, ETFs have started making inroads into investor portfolios due to their cost and liquidity benefits. ETF market started attracting a big chunk of the investors’ money in the developed markets and these are yet to pick up in India.  ETFs now represent everything from broad market indices to niche sectors or alternative asset classes.

Here, we will talk about ETFs in detailed manner.

Understanding Exchange-traded fund (ETF)

ETFs have grown in popularity largely because it’s become cheaper  (An expense ratio are much lower for ETFs than mutual funds), easier to invest in the stock market, and offer tax efficiency. Also,  it don’t require a minimum amount in investing. They are passively managed Index funds listed on stock exchanges that contain all the stocks which carry the same net asset value of the underlying index, and they can be purchased and sold in real-time at a price that varies throughout the day.

Scope of the ETF Market

Over the last few years, most actively managed funds are trying to beat a market (a benchmark index like the S&P 500) but according to statistics, they all fail most of the time and not performed according to the investor’s expectations. This brings ETFs in to ahead. From 2015, the Indian ETF market has experienced a good AUM growth. The CPSE ETF played a major role in boosting the ETF market, in 2015, the Employees’ Provident Fund Organization or EPFO also decided to increase its equity investments via ETFs.

Difference between ETFs and mutual funds

Unlike index funds or other mutual funds, ETFs can be traded freely in the market and it’s up to your will as to when you want to buy or sell your units, and they experience price changes throughout the day whereas mutual funds are valued once in a day. It is an appealing option for investors with limited expertise of the stock market.

When investor want to buy units of an ETF, they will do it directly from other investors in open market just like any other stock . This is quite different from an actively managed mutual funds, here it involve creation of additional units. The fund manager purchase additional securities according to investor purchase request.

ETFs known to be very cost effective when compared to other funds, this has a significant impact on returns over time and also ETFs are very transparent in nature with a simple structure. If we don’t want to spend very much time on investing in the stock market, ETFs could be the right way to invest.

ETFs don’t come with high charges since they don’t need to be managed actively .There is no lock-in period for an exchange-traded fund.  ETFs have a higher liquidity ratio since they are relevant to the liquidity of the stocks in the index.

ETFs provide more tax benefits to its investors as compared to mutual funds.

Make a smart investment option

Here we will take an example of Nippon India Nifty 50 Bees ETF and Nippon India index fund-nifty plan to compare various factors for better investment decision.

  1. Trailing returns since last 7 years in Nippon India Nifty 50 Bees ETF (13%)are higher than Nippon India index fund-nifty (Direct Plan) returns (12.62%).

  2. Tracking error of Nifty Bees – 0.03%, which is very low compared with Nippon index fund – 1.60%.

  3. Expense ratio also very low in Nifty Bees (0.05%) in comparison with Nippon Index fund (0.15%)

  4. Liquidity was the only concern in ETF, we need check the buyers and sellers availability in market for ETF. But liquidity is very in high mutual funds .

Exchange-traded fund (ETF) are undoubtedly more cost-efficient and investor-friendly as compared to mutual funds. Sometimes, economy impacted due to multiple challenges such as a bad monsoon, rising prices of essential commodities. In such conditions, liquid investments take precedence over long-term investments, investors needed an investment that provided high liquidity while offering reliable returns. However, before you make any decisions, understand the functionality behind the funds, assess the market risks you’re willing to take and consult with an expert.

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