Equity markets are rising, you are not fully invested but you are worried about potential falls? Then look at ETF’s for investment. ETF’s gives you exposure to the benchmark equity index stocks, in India its Nifty or Sensex, in US its S&P 500, you get market performance, you do not need to pay fees as expenses are low, you can buy and sell whenever you want and you do not have to worry about your investment as you would if you invested in a stock. A company can face many issues from business disruptions to poor management and that can hurt your investment but in an ETF you only have to worry about the factors that can cause broad markets to fall or rise, and these factors are tracked by almost everyone and anyone.
ETF’s in India
As a sign of growing investor interest in exchange-traded funds (ETFs) the assets base of ETFs around the world reached $3 trillion at the end of first quarter of 2016. Assets were spread across more than 270 global providers and were listed on 64 separate exchanges throughout 51 countries (Source London-based ETFGI LLP), In United States ETF assets were $2.15 trillion by the end of first quarter of 2016, approximately 71.5% of global ETF assets.
In India assets base of ETFs has surpassed Rs 280.47 Billion (Source AMFI India) as of 31st August 2016, It was at Rs. 133.55 Billion on 31st August 2015. The share of ETFs benchmarked to Nifty indices now command an impressive market share of 85% to the total Equity ETF volume. However, ETF’s are yet to see strong penetration in India, with a minuscule size as compared to its global peers.
What are ETFS?
Exchange Traded Funds are like stocks but are offered for investments by mutual funds. Like an index fund, an ETF represents a basket of stocks that reflect an index such as the Nifty. An ETF however isn’t a regular mutual fund, it trades just like any other company on a stock exchange. Unlike a mutual fund that has its net-asset value (NAV) calculated at the end of each trading day, an ETF’s price changes throughout the day, fluctuating with the value of stock prices.
How do ETFs work?
In a normal mutual fund, we buy/sell units directly from/to the AMC. First the money is collected from the investors to form a corpus. The fund manager then uses this corpus to build and manage the appropriate portfolio. When we redeem our units, either the cash portion of the portfolio is utilised or a part of the portfolio is sold and we are paid for our units.
In an ETF, we have entities called authorized participants who are appointed by the AMC (Asset Management Company). They will first deposit all the shares that comprise the index (or the gold in case of Gold ETF) with the AMC and receive what is called the creation units from the AMC. Since these units are created by depositing underlying shares/gold, they are called in-kind units. These creation units are a large block, which are then split into small units and accordingly bought/sold in the open market on the stock exchange by these authorized participants. Therefore, technically every buy and sell need not change the corpus of an ETF unlike a conventional Mutual Fund unit.
However, when there is more demand, these authorized participants deposit more shares with the AMC and get more units created to satisfy the demand. Or if there is excessive redemption, then they give back these creation units to the AMC, take back their shares, sell them in the market and pay the investor.
What Will an ETF Comprise of?
If you buy an Index based ETF it will give you a very similar return as the index it tracks. (The return may be slightly lower because of a small tracking error and expense ratio).It can be bought and sold real time during market hours.
For example: A Nifty ETF will comprise of stocks exactly in the same ratio as a Nifty. You can buy and sell them from an equity broker just like any stock and the price of ETF will move real time just like the Nifty moves.
Why are ETf’s Called Passive Funds?
A ETFs Fund Manager invests in the same securities, and in the same proportion, as an index such Nifty or Sensex. The ET Fund manager does not make decisions about which securities to buy and sell, he merely follows the same methodology of constructing a portfolio as the index uses. Since ETF’s do not actively look for stocks opportunities to buy or sell, they are called passive funds.
Why Should an Investor Invest in an ETF?
If you are planning to invest in equities but unsure as to which stocks to buy or which mutual fund scheme to invest into, ETFs can come to your rescue. Investing in an ETF will help you ride market upswings even as you go about building a portfolio of stocks or MF schemes.
Hence, if Nifty index rises 10% before you start investing in equities, the ETF investment will help take full advantage of the 10% rise in the index. ETF has ease of trade and implicit diversification No new mutual fund KYC forms have to be filled and the minimum investment is just one unit, which is typically a few hundred rupees.
Typically the expense ratio charged to an ETF is much lower than a mutual fund scheme.
An ETF will lie in your demat account just like a share while providing the diversification. (Closed-ended Mutual funds are also listed on the exchange; they are usually illiquid and are quoted at a discount to the NAV).
All tax benefits to stocks like long-term gains currently apply to ETFs unlike mutual funds. ETFs also allow for intraday trading because their prices change real time.
Please do remember that you will have to pay your equity broker the normal commission as you pay in stocks.
What are the ETF’s Available in India?
List of ETFs which are listed in NSE