Know about Exchange Traded Funds or ETF

Exchange traded fund or ETF is passive schemes, which invest in a basket of securities constituting a market index.  Unlike actively managed mutual fund schemes, ETFs do not aim to beat the index, they simply aim to track the index as closely as possible. Each security in an ETF has the same weight as it has in the index. For example, if a stock has 5% weight in the Nifty, the same stock will also have 5% weight in a Nifty ETF. ETFs also track the price of commodities like Gold. The value of one Gold ETF unit represents the value of a certain weight of Gold. We also have ETFs of different types of fixed income investments like TREPs (liquid), G-Secs (Gilt) etc.

What are benefits of exchange traded funds?

ETFs have much lower costs compared to actively managed mutual funds Lower the cost, higher the returns for a given level of performance by the market index.

Actively managed funds have unsystematic risks because these funds are overweight / underweight on certain stocks / sectors relative to the benchmark index. There is no unsystematic risk in exchange traded funds.

ETFs tracking market capitalization weighted indices have lower allocations to underperformers and higher allocation to outperformers. Actively managed schemes may have stock-wise concentration limits for the sake of diversification.

ETFs are not subject human biases or errors of judgement and risks thereof. They are only subject to asset class related market risks.

What are the differences between Exchange traded funds and mutual funds?

Actively managed mutual fund schemes aim to beat the index, while ETFs track the index.

Total Expense ratios (TERs) of ETFs are much less than TERs of actively managed mutual funds.

Mutual fund transactions (buy / sell) take place on basis of end of day NAVs, while ETF transactions take place on the basis of current bid ask prices (buy / sell offers) in the market (exchange) like stocks.

Mutual fund units can be redeemed with the AMC, while ETF units can be sold only on stock exchanges unless you are transacting in lot sizes (creation units) specified by the AMC.

You need to have Demat and trading accounts to invest in ETFs. Demat accounts are not necessary for investing in mutual fund schemes.

What are different types of exchange traded funds?

Equity ETFs: These ETFs invest in equity market securities e.g. stocks and track equity market indices (e.g. Sensex, Nifty, Bank Nifty, Nifty 100, Nifty 500 etc).

Commodity ETFs: These ETFs track commodity prices (e.g. Gold, Silver) and are backed by physical commodities.

Fixed income ETFs: For Fixed income investments, ETFs invest in debt and money market securities e.g. TREPs, Gilts, State Development Loans (SDLs), PSU bonds etc.

How can you invest in exchange traded funds?

ETFs are listed on stock exchanges and traded like shares of companies. You need to have Demat and trading accounts to invest in ETFs.

During the New Fund Offer (NFO) period, you can subscribe to units of the ETF at face value.

After the NFO period, you can buy / sell ETF units only the stock exchange, unless you are transacting in lot sizes. If you are transacting in lot sizes, as specified by the AMC, you can buy / sell ETF units directly with the AMC

You should invest in ETFs according to your risk appetite and investments.

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