Exchange Traded Funds, better known by the acronym ETFs, might sound highly technical to you or may be a little bit scary, but, in reality these are friendly index funds that are listed and traded on stock exchanges. Exchange Traded Funds are designed for individual investors.
ETFs are called exchange traded funds because they’re traded on a stock exchange just like shares are.
Exchange traded funds (ETFs) pool the financial resources of several investors and use it to purchase various tradable monetary assets such as shares, gold, commodity, debt and other securities in order to generate more money for its investors. Therefore, exchange traded funds allow you to invest in lots of securities all at once. It operates much like a mutual fund.
But unlike mutual funds, an exchange traded fund is a marketable security, meaning it has a share price that allows it to be traded on a stock exchange throughout the day the same way a regular stock can.
How do Exchange Traded Funds work?
Depending on the objective of the Exchange Traded Fund, an ETF portfolio usually represents a certain index or segment of the market. Most popular ETFs or exchange traded funds represent the composition of an index, like Nifty 50, BSE Sensex and S & P.
For instance, if an ETF is based on NIFTY 50 index, then it means the fund manager has considered only those stocks to invest that are placed in NIFTY 50 in the same proportion or weightage of NIFTY 50. They don’t consider any other stocks to invest in.
If NIFTY 50 includes and excludes a stock from its index, then the fund manager does the same to have the fund in sync with the index NIFTY 50.
At the beginning when the ETFs are created, the owner or the asset management company raises money through a process known as NFO or new fund offer.
Investors interested in NFOs participate based on the terms and conditions fixed. Money raised through NFOs, are invested based on the objective of the fund. The asset management company behind this ETF is known as the owner of the exchange traded fund.
The owner of the ETF owns the underlying assets, designs the fund based on its objective to track their performance and then allot shares in that fund to the initial investors. As an initial investor to NFOs, you get your shares based on the contribution you made in proportion to the total fund raised.
All those shares issued to ETF participants get listed in stock exchange so that it can be easily bought and sold by market participants.
As a shareholder of the ETF, you own a percentage of ownership of the ETF, but you don’t own the underlying assets in that fund.
Performance of your ETF is directly tied to the value of the underlying securities. If the price of reliance industries, HDFC twins and other stocks goes up, so does the value of your exchange traded fund which has mirrored NIFTY 50. In simpler words, if NIFTY 50 goes up, your value of the ETF based on NIFTY 50 goes up, if NIFTY 50 comes down, then the value of the ETF based on NIFTY 50 also declines.
The price of the ETF’s share changes throughout the trading day based on market value of the securities it holds.
Exchange traded funds don’t try to outperform their corresponding index, but simply replicate the performance of the index. In simple terms, these ETFs don’t try to beat the market, they try to be the market.
A share of an ETF represents ownership in a basket of company stock. To buy and sell an ETF, you place an order with a broker, either by phone or online.
For example, if you buy 100 shares of an ETF @ 180 a share which has mirrored NIFTY 50, then you would be indirectly buying a portfolio of stock worth Rs. 18,000 that would include all the shares that are part of NIFTY 50 index.
Types of ETFs
ETFs are developed to mirror various indices. Most popular ETFs in India have mirrored BSE Sensex and Nifty indices. Likewise, in the USA, ETFs have mirrored SPY, DIA and NASDAQ-100 index.
Sometimes indexes are created based on segments/sectors such as information technology, auto, bank, consumer and metal. We have ETFs that mirror these sectoral indices. Various types of ETFs are available to investors. Here are the most important Exchange Traded Funds available in the market today.
Stock ETFs
Probably the most known and popular exchange traded fund is equity or stock ETFs.
Stock ETFs are designed to comprise a basket of stocks to mirror broad market index or sectoral index of a stock exchange. The best example is Exchange Traded Funds that mirrored the NIFTY 50 index.
Nifty 50 ETFs
Nifty 50 ETF scheme consists of top 50 large companies as per free float market capitalization. It is a passively managed scheme which is replicating/tracking the Nifty 50 Index.
Passive management or passively managed means the fund manager references a published index to determine which securities to hold and how to weight those securities in their portfolio. If required, they make only minor or periodic adjustments to keep the fund in line with the index. Active participation of the management (continuously trading assets in an effort to outperform the market) is very less as the objective is just to replicate the index.
The main objective of the scheme is to provide returns that, before expenses, closely correspond to the total returns of the securities as represented by the underlying index.
If buying all scripts that are part of NIFTY 50 is not possible, then to earn the same return that NIFTY 50 gives, one can consider investing in an ETF that tracks NIFTY 50.
Here is a list of NIFTY 50 ETFs traded on NSE;
| ETFs | SYMBOL |
| Indiabulls NIFTY50 Exchange Traded Fund | IBMFNIFTY |
| Quantum Nifty 50 ETF | QNIFTY |
| Aditya Birla Sun Life Nifty ETF – Growth | BSLNIFTY |
| HDFC Mutual Fund – HDFC Nifty ETF | HDFCNIFETF |
| Axis Mutual Fund – AXIS NIFTY ETF | AXISNIFTY |
| SBI-ETF Nifty 50 | SETFNIF50 |
| ICICI Prudential Nifty ETF | ICICINIFTY |
| Invesco India Nifty Exchange Traded Fund | IVZINNIFTY |
| Kotak Mahindra Mutual Fund-Kotak Nifty ETF | KOTAKNIFTY |
| NIPPON INDIA ETF NIFTY BEES | NIFTYBEES |
| UTI Mutual Fund – UTI-Nifty Exchange Traded Fund | UTINIFTETF |
| Mirae Asset Mutual Fund – Mirae Asset Nifty 50 ETF | MAN50ETF |
| LIC MF – LIC MF EXCHANGE TRADED FUND – NIFTY 50 | LICNETFN50 |
| Motilal Oswal Mutual Fund – Motilal Oswal M50 ETF | MOM50 |
| IDFC Mutual Fund – IDFC Nifty ETF | IDFNIFTYET |
| Tata Nifty Exchange Traded Fund | NETF |
| DSP Mutual Fund – DSP Nifty 50 ETF | DSPN50ETF |
Here is a list of other major ETFs traded on NSE;
| ETFs | SYMBOL |
| MOTILAL OSWAL MUTUAL FUND – MOTILAL OSWAL NASDAQ 100 ETF | MON100 |
| NIPPON INDIA ETF GOLD BEES | GOLDBEES |
| NIPPON INDIA MUTUAL FUND – NIPPON INDIA NIFTY PHARMA ETF | NETFPHARMA |
| NIPPON INDIA ETF LIQUID BEES | LIQUIDBEES |
| NIPPON INDIA MUTUAL FUND – NIPPON INDIA ETF NIFTY IT | NETFIT |
| NIPPON INDIA MUTUAL FUND – NIPPON INDIA SILVER ETF | NETFSILVER |
| NIPPON INDIA ETF BANK BEES | BANKBEES |
Apart from stock Exchange Traded Funds, we also have bond, commodity and currency ETFs. The main objective of Bond Exchange Traded Fund is to provide regular income to investors based on the performance of underlying bonds. They can include government bonds, corporate bonds and other bonds.
Likewise in commodity Exchange Traded Funds, the main focus is on different commodities such as crude oil, gold and silver.
Benefits of Stock or Equity Exchange Traded Funds
Like any other financial security, Exchange Traded Funds have their own advantages and a few disadvantages over a traditional mutual fund.
Playing with individual stocks can be dangerous to investor’s wealth. Any stock specific correction can affect your net wealth based on your investment size. That is why busy people or average investors prefer to own a lot of stocks either through Exchange Traded Funds or mutual funds.
Exchange Traded Funds let investors diversify across different industries, company sizes, stocks, and other financial securities. To get the diversification that exchange traded funds offer, retail investors need a lot of money, expertise and effort to buy all the components of a particular basket, but you can do the same with the click of a button to buy an ETF. This diversification will help you to be protected against non-systematic risk.
Management fee and other charges in comparison to a mutual fund is very less. Which helps investors to save more in the long run. Tax benefits on an ETF is the same as its applicable to a mutual fund.
The first disadvantage of an Exchange Traded Fund is that you have to incur brokerage commission for buying and selling of exchange traded funds on the stock exchange. You have to check with your broker about the brokerage commission they charge on buying and selling of ETFs.
The second and most important disadvantage of an Exchange Traded Fund is liquidity. Buying and selling of Exchange Traded Funds depends on the market price of the fund based on the demand and supply. If the ETFs that you bought are not traded frequently, then it may be a difficult task for you to get a better exit price.
ETF Vs. Mutual Fund
Here are the most important differences between ETFs and mutual funds;
- ETFs are traded just like individual stocks. This means you can place a buy or sell order through a broker. Price of the ETF changes from second to second based on the portfolio of stock it has. However, in the case of a mutual fund, you can place your order during the day, but the actual trading will take place after the market closes. All day trading on the stock exchange makes ETFs more flexible than the mutual funds, where investors must wait until the end of the day to buy or sell shares directly with a mutual fund company.
- ETFs are passively managed as they tend to represent indexes. Mutual funds require active management for trading in securities. Due to this, you are required to pay less in management fees compared to mutual funds. In addition to it you will have less trading costs and spread costs as little trading is done in ETFs.
- No minimum and maximum limits are fixed to buy and sell ETFs through stock exchanges. You can buy and sell anytime during market hours.
- Market price of Exchange Traded Funds is determined by forces of supply and demand. Mutual funds are traded at their net asset value (NAV), that is combined market value of the underlying securities and cash holdings. Market price of Exchange Traded Funds is kept close to its NAV as supply and demand for ETF shares is driven by the values of the underlying securities in the index they track.
Are ETFs Risky?
Well, that all depends on the kind of ETF we are talking about.
Indexed ETFs and mutual funds eliminate non-systematic risk. It’s the kind of risk that is involved when you invest in any individual security. For instance, in stocks like SATYAM, YES Bank, DHFL, and Manpasand Beverages, investors lost their hard earned money when stock prices took a sudden nosedive due to mismanagement in the company. These kinds of risks can be eliminated by investing in Exchange Traded Funds or mutual funds.
Do remember, mutual funds and Exchange Traded Funds can not eliminate systematic risk. Systematic risk includes market risk, interest rate, inflation and political risks.
The most important risk as an individual investor you must look at is unsystematic risk.
Some Exchange Traded Funds track individual sectors of the country’s economy, like metal, technology, auto, power, consumer, infrastructure etc., these can be extremely volatile based on the sector’s performance. Exchange Traded Funds tracking broader segments of the market such as NIFTY 50, Sensex and S&P 500 can be volatile based on systematic risk, but less in comparison to others.
Simple steps to begin investing in ETFs
As discussed above, like any other financial security, Exchange Traded Funds have their own risk. You can follow below mentioned steps to begin investing in ETFs.
- Open a trading account with a broker which offers less brokerage commission and allows you to trade ETFs.
- Fund your trading account before investing.
- Research about the Exchange Traded Funds and its management. We have a wide variety of ETFs in the market. You need to focus on the specific indices and industry they invest in and the management behind it.
- Know how liquid the ETFs are. You need to look at the demand and supply of Exchange Traded Funds in the market. If the ETFs do not have volume, then try to avoid trading it. Trading volume will let you know how popular the Exchange Traded Fund is and how frequently it’s traded in the market. Less or no volume indicates that it will be difficult for you to trade that fund. Therefore, it is advisable to select ETFs that have higher liquidity. The average daily volume of the ETF indicates how easily you can liquidate your holdings in the market.
Instead of trading in existing ETFs listed in a stock exchange, investors can also participate in new fund offers.
NFO or new fund offer is a first time subscription offer for a new scheme that has been launched by an asset management company (AMC). It can be for ETFs or normal mutual funds. You can participate in NFO, but remember to read the terms and conditions first. Remember when you buy ETFs through a stock exchange, you don’t have any restriction on the number of units to buy and sell, however during NFO, asset management companies may fix the minimum price or limit of investment in addition to other terms and conditions.
Link to help you track various exchange traded funds.
Disclaimer: In addition to the disclaimer below, please note, this article is not intended to provide investing or trading advice. This article is for information purposes only. It is not a stock recommendation and should not be treated as such. Trading in the stock market and in other securities entails varying degrees of risk, and can result in loss of capital. Most investors and traders lose money. Readers seeking to engage in trading and/or investing should seek out extensive education on the topic and help of professionals.
