What is ETF in India? How it can be benefited as the best passive investing option?

If you are looking for the answer to the question, What is EFT in the Indian Stock market? You have landed on the right page. What does ETF stand for? An ETF stands for Exchange Traded Fund, which unlike regular Mutual Funds trades like a common stock on a stock exchange. The units of an ETF fund are usually bought and sold through a registered broker of recognized stock exchanges. The units of an ETF are listed in stock exchanges and the NAV varies as per market movements.

Since units of an ETF fund are listed in the stock exchange only, they are not bought and sold like any normal open-ended equity fund. An investor can buy as many units as he/she wishes without any restriction through the exchange. In simple terms, ETFs are funds that track indexes such as CNX Nifty or BSE Sensex, etc. When you buy shares/units of an ETF, you are buying shares/units of a portfolio that tracks the yield and return of it's native index.

The main difference between ETFs and other types of index funds is that ETFs don't try to outperform there corresponding index, but simply replicate the performance of the Index. They don't try to beat the market, they try to be the market. ETFs typically have higher daily liquidity and lower fees than Mutual Fund schemes, making them an attractive alternative for individual investors. I hope this answers your question what is EFT?

ETFs & Index funds replicate/track a particular index & minimum investment in securities of a particular index that is being replicated/ tracked is 95% of the total assets. Thus, it’s a passively managed investment that mirrors the composition of the underlying benchmark index. And the main aim of this investment is to generate returns in line with the benchmark index, with less tracking error. One can invest in different asset classes (Equity, Debt & Gold, etc.) and sectors such as Banking, Infrastructure, Healthcare, etc. through ETFs & Index funds.

Indices are rebalanced & reviewed regularly with a predefined criterion. During the rebalancing period stocks which are not meet eligibility criteria are replaced with new ones. So, this is an automated system of making winners’ portfolios without human intervention. Thus with the help of ETFs / Index funds, you can easily invest in winner's portfolios without individual biases or subjectivity opinions.

How Investing in ETF can be benefited as the best passive investing option?

• If you are looking to invest in stocks but don’t have the time and research capabilities to choose the appropriate stocks for your portfolio, ETFs are a great savior! Easily you can invest in ETF. ETFs, help you participate in the stock market with much more ease than investing in individual stocks without compromising liquidity. They offer greater diversification at a lower cost compared to direct stock investing.
• An ETF or Exchange Traded Fund is a type of mutual fund listed on the stock exchange and can be traded in real-time like any other stock listed on the exchange. Since ETFs are a type of mutual fund, there portfolio comprises a basket of securities that mirror the composition of a market index. Thus, you get to invest in selected stocks that are part of a market index without having to spend your time and energy researching to select a few stocks. ETFs are cost-effective not just compared to stock investing but also other categories of Mutual funds due to there low expense ratio.
• ETFs are also available in the bond market, allowing you to gain exposure to the debt asset class just like any Debt Mutual Fund. You can cost-effectively invest in a broad basket of company bonds or stocks depending on your investment needs and trade in them just like stocks or bonds.
• ETFs & Index funds can be a good choice for ‘know-nothing’ investors who want to invest in the stock market but have limited knowledge about investing. They are also preferred by seasoned investors for diversifying the portfolio. Passive investing eliminates human discretion/bias while taking investment decisions as fund managers need to replicate the index composition by mandate. Diversification of the portfolio by investing in different asset classes & sectors which are a part of the index.
• Since ETFs & Index funds are open-ended funds & there is no lock-in period involved, investors get the benefit of liquidity. Thus, they can withdraw investments as per requirement. Low Management fees, as these funds replicate a particular index it doesn’t require a team of research analysts for the stock selection process & active fund management. ETFs are actively traded on stock exchanges on a daily basis, just like intraday trading which offers flexibility & simplicity to investors in making investment decisions.

What are the types of ETF?

Index-Based ETF –

• The index ETF is a replica of the index which they are representing. In India, we broadly have Nifty 50 and Sensex 30 index. Along with this broader index, there are other ETFs that replica of the index like Nifty next 50, Nifty Midcap 150.

Thematic Index-Based ETF –

• These are theme-based or sector-based ETFs. For example, we have IT ETF, Banking ETF, PSU Bank ETF which are a replica of the index of the theme of Nifty.

Bond / Debt ETF:

• These are funds that only invest into debt or bonds. Normally there are liquid ETF, Govt. Bond ETF and PSU Bank bond ETF.

Gold ETF:

• The ETF only invests in a Gold commodity.

Other ETF:

• There are specific ETFs that are linked to a volatility index, dividend yield opportunity, etc.

Following asset allocation as per risk profile while investing & regular rebalancing of the ETFs & Index funds portfolio can generate superior returns. Passive investing is suitable for investors who have a long-term investment horizon.

ETFs & Index funds with low tracking error, large AUM, and reasonable cost could be a prudent choice of investment.

What are the limitations of ETF?

• ETFs are passive investment tools that track an underlying index and trade on exchanges just like shares. But ETFs need to be bought and sold from the exchange through a broker. You need to have a Demat account to trade in ETFs and need to pay commission to the broker for every transaction. If you are tempted to invest in ETFs to capitalize on there real-time trading, the commission cost can lower your returns over time.
• Secondly, ETFs don’t offer the benefit of rupee cost averaging that is available in mutual funds through SIP. If you want to make regular investments in ETFs, you’ll also have to bear the commission cost on every transaction. ETFs don’t offer features like growth and dividend options where investors can choose an option best suited to there financial goals. For instance, ETFs can’t meet the requirement of a retiree seeking regular income or someone seeking dividend payout on regular basis.
• Some ETFs are niche or sector-specific and are thinly traded. Investors could face a wide bid/ask spread (the deviation in the current price of ETF from it's NAV) while transacting in ETFs. While ETFs offer intraday trading opportunities that may be tempting in the short term, they could be detrimental to a long-term financial plan. So what are you waiting for? With us, it's easier and hassle-free to invest in ETF.