The ABC of Exchange Traded Funds

Exchange traded funds or ETFs have revolutionized the global investment industry in recent times due to their simplicity, low costs and ease of use.

In India, exchange traded funds have been in existence for quite some time now. But they have not been able to attract investors' attention and money unlike its global peers.

The foremost reason for ETFs not being popular among investors in India is the lack of understanding of the concept of ETF. What are ETFs? How are they different from a normal MF? How does ETF work? Are ETFs worth investing? We look at the answers to these and some other common queries regarding the ETFs.

Q: What is an Exchange Traded Fund (ETF)?

An exchange traded fund (ETF) looks like a mutual fund that tracks an index, a commodity or a basket of assets like an index fund, but trades like a stock on an exchange. ETFs experience price changes throughout the day as they are bought and sold throughout the trading day.

When you buy shares of an ETF, you are buying shares of a portfolio that tracks the yield and return of its native index.

Buying/selling ETFs is as simple as buying/selling any other stock on the exchange allowing the investors to take advantage of intra-day price movements. The main difference between ETFs and other types of index funds is that ETFs don't try to outperform their corresponding index, but simply replicate its performance. ETFs don't try to beat the market, they try to be the market.

Ques: What are the advantages of ETFs?

1. Convenience - ETFs can be bought/sold any time of the day when the market is open, as they are traded on a real time basis.

2. Diversification - By investing in ETFs an investor can enjoy the diversification benefits of an index fund with the flexibility of a stock.

3. ETFs can be bought and sold anytime during market hours at a price which closely replicates the actual NAV of the scheme.

4. With a small amount of money an investor can get the benefit of an entire underlying asset which could be an Index or a commodity like gold.

5. Lower expense ratio - ETFs are managed passively. Hence administrative charges are low which pushes down the expense ratio.

6. Tracking error, which is divergence between the NAV of the ETF and the underlying Index, is generally observed to be low as compared to a normal index fund due to lower expenses and the unique in-kind creation / redemption process.


Source: Economic Times

Thanks and Regards,
Sanchari Sinha,
Intern at DENIP Consultants Pvt. Ltd.