Exchange Traded Funds (ETF)

An Exchange Traded Fund (ETF) is similar to a mutual fund scheme that is created to track and mirror the performance of stock market indices such as Sensex, NIFTY 50, NIFTY Bank, NIFTY Next 50 etc. Exchange-Traded Funds (ETFs) are considered passively managed funds as the portfolio managers do not try to outperform but mirror the performance of the underlying stock market index. 

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Benefits of ETFs

  • Easy Diversification

    Diversify portfolio to an entire index instead of a single stock.

  • Low Cost

    ETFs often cost less than traditional Mutual Funds.

  • Flexibility

    Can be bought & sold at any time on Exchange.

  • Tax Efficiency

    ETFs have lower capital gains and they are payable only upon sales of the ETF.

  • Transparency

    Most ETFs disclose their holdings on a daily basis.

ETFs include the characteristics of both mutual funds and shares. They are listed on stock exchanges like company shares. An Exchange-Traded Fund (ETF) is produced via a creation block (a block of new shares sold by the ETF) and can be bought and sold by investors during the equity trading time from stock exchanges. ETFs include a basket of securities that are manually created to track the performance of anything from a specific sector to an individual commodity. 

The ETF share price fluctuates similarly to equities based on the prices of the underlying assets included in the basket of securities. Hence, ETFs trade differently from mutual funds, which only trade once a day after the stock market closes. Exchange-Traded Funds (ETFs) also pay a dividend to the investors based on the asset management and the performance of the concerned ETF company. 

Here are the various types of Exchange Traded Funds (ETFs): 

Equity ETFs

Equity ETFs include stocks of various listed companies in their basket of securities in a predetermined proportion. Commonly, equity ETFs track the performance of a single industry such as metal, FMCG etc. 

Bond (Debt) ETFs

Bonds ETFs include a basket of bonds from various bond categories, such as state bonds, government bonds, corporate bonds etc. Bonds ETFs provide a regular source of income to the investors through regular interest payments based on the performance of the included underlying bonds. 

Gold ETFs

Gold ETFs are created to track domestic gold prices and allow investors to invest passively in gold bullion without the need to buy physical gold. Similar to equity ETFs that buy a unit of ‘stock’, gold ETFs invest in buying units of pure gold where one unit equals one gram of gold. 

Currency ETFs

Currency ETFs allow investors to trade in a basket of currency pairs (currencies are always traded in pairs) and track their price and performance. The ETF share price of such ETFs fluctuates based on the overall exchange rate. 

Commodity ETFs

Commodity ETFs include a basket of commodities from various segments such as agriculture, livestock, metal etc., and allow investors to profit from the price fluctuations of underlying commodities. 

Before you select an Exchange Traded Fund, it is important to narrow down your investment goals, how much capital you can invest comfortably and the motive behind your investment. Then,  consider the following points to compare and choose the best ETF: 

Fund Size: Although there are no set rules around the size of funds, it is better to invest in an ETF that has a large pool of assets (fund size). The reason behind choosing an Exchange Traded Fund with a large fund size is that the higher the fund size, the higher the investor buying interest. As the investor buying interest is higher for large funds, investors can find higher liquidity with lower costs. 

Period: When choosing the best ETF, it is important to analyse the past performance. However, new Exchange Traded Funds do not have significant historical data to analyse to assess their performance. Therefore, choose ETFs that are trading for at least a couple of years to analyse their performance in detail. 

Costs: The expense ratio of an Exchange Traded Fund is lower than that of a mutual fund as they are passively managed. However, two ETFs can have different expense ratios resulting in different overall costs. Compare and analyse ETFs based on their expense ratios; the lower the ratio, the lower the overall costs and higher the profits. 

Trading Volume: As ETFs trade similar to stocks on the stock exchanges, you can analyse the investor demand based on their trading volumes. A higher trading volume means that the particular ETF has a higher demand and can provide better returns than ETFs that are trading lower in volume.