Ever since their launch in the USA in 1993, Exchange Traded Funds or ETFs have grown in popularity around the globe. In India, ETFs were launched in 2002 by Benchmark Mutual Fund. The first ETF to be launched in India was Nifty BeES (Nifty Benchmark Exchange-Traded Scheme). While most investors are aware of stocks and mutual funds, there is a lot of ambiguity when it comes to understanding ETFs.Today, we will be offering a beginner’s guide to investing in ETFs.
P.S: You can now invest in ETFs on Groww!. All you need to do is, login to your account and enter the name of the ETF you want to invest in the search bar. You will be able to then place your order during market hours. With Groww, investors can check all information related to ETFs such as expense ratio, fund manager details, scheme objectives as well as track the live price of the underlying securities on-the-go. Please note, you will need a Demat account to start investing in ETFs on Groww. If you haven’t opened a Demat account on Groww yet, here’s how you can do so within minutes!
Read More: How to open a Demat account on Groww
What is an ETF?
To begin with, an Exchange Traded Fund or ETF is a mutual fund. It pools funds from multiple investors, has a fund manager, and Net Asset Value like a mutual fund. However, there are two striking features of an ETF that make it unique:
- An ETF can be traded on a stock exchange just like shares (in the secondary market)
- It is a passively managed fund and usually tracks an index and has evolved as one of the most popular forms of passive investing in India.
The first ETF in India, Nifty BeES tracks the movement of the Nifty 50 Index. Hence, the fund manager purchases stocks from the Nifty 50 that allow the fund to offer returns similar to those of the index.
ETFs are listed on a stock exchange like stocks. Investors can trade them like stocks and the price of each unit of the ETF is not determined by the NAV but by the demand and supply in the market. They need to open a demat account and a trading account to be able to trade in ETFs.
1. Categories of ETFs
ETFs can be broadly classified into four categories:
- Equity ETFs – These exchange-traded funds track the movement of stock indices or a collection of stocks from a particular sector or industry. The idea is to replicate the performance of the index or the sector by investing in stocks accordingly.
- Gold ETFs – Investing in gold is considered a great hedge against currency fluctuations and economic downturns. However, investing in physical gold has several concerns like security, quality, resale, taxation, etc. Gold ETFs invest in gold bullion and allow investors to include gold in their portfolio without the hassle of investing in physical gold.
- International exposure ETFs – Some ETFs track stock indices of international markets. They allow investors to gain exposure to international markets and participate in the growth stories of certain economies.
- Debt ETFs – These exchange-traded funds invest in fixed-income securities.
Why Should You Consider Investing in ETFs?
An ETF is an excellent way to invest in stocks in a diversified manner. When you invest in stocks, you can buy limited stocks based on your investment corpus. Hence, choosing the right stocks becomes important. However, if you invest in an ETF that tracks a sector or asset class, then you gain exposure to a wider range of securities making your portfolio diversified and robust. Here are some benefits of investing in ETFs:
- You can easily trade ETFs on stock exchanges like shares
- Since units are traded at market prices that are determined by investor sentiment, you get an opportunity to make profits if the market perception is in favor of the sector/market that the ETF tracks
- You can buy and sell units throughout the day unlike mutual fund units where you can redeem them at specific times to get the benefit of the prevailing NAV
- The expense ratio of an ETF is usually lower than most regular mutual funds (especially actively managed mutual funds)
ETFs vs. Stocks vs. Mutual Funds
Now that you understand an ETF, its categories, and advantages, let’s take a look at a quick comparison between ETFs, stocks, and mutual funds:
|What is it?||A basket of securities that tracks an underlying index or sector.||Single security that signifies ownership in a company.||An investment avenue where funds are pooled together and invested in different asset classes based on the objective of the fund.|
|Risks||A diversified approach to an asset class. Carries market-related risks though.||Higher risks since the performance of the stock depends on that of the company.||Diversified exposure but carries market-related risks.|
|When can you trade?||ETF units can be traded throughout the day.||Stocks can be traded throughout the day.||Mutual fund trades are fulfilled only once a day after the market closes.|
|Control||Less control than stocks but more than mutual funds.||The most control over the investment.||The least control over the investment.|
How to Select the Right ETF to Invest in?
There are many ETFs available in India to invest in. Here are four aspects that you must consider before choosing an ETF to invest in:
1. Category of the ETF
As explained above, ETFs can be divided into four categories – equity, gold, international, and debt. Once you select the category, you need to also look at the sub-categories. For example, if you decide to invest in an equity ETF, you will have to choose between ETFs that are focused on specific sectors or market capitalizations, etc.
2. Trading Volume of the ETF
Since the launch of ETFs in India in 2002, the trading volumes of ETFs have increased. While earlier investors were unable to sell ETF units at will, things are way different now. However, there are some ETFs that still have lower trading volumes as compared to the others. If you need liquidity and a good price for your units, it is important to choose an ETF with high trading volumes.
3. Expense Ratio
As mentioned earlier, the expense ratio of an ETF is lower than an actively managed fund. Many fund houses offer further discounts on expense ratios to attract more investors. A lower expense ratio means better chances of earning good returns.
4. Lower Tracking Error
ETFs are usually designed to track an index. They invest in securities that comprise the index in a manner that the returns ‘closely resemble’ those offered by the index. Hence, there is always some difference between the returns offered by the index and the ETF. Tracking error is used to measure the variance in the performance of the ETF with respect to the underlying index. It is also defined as the standard deviation of daily return differences by the index and the ETF. The lower the tracking error, the closer the returns of the ETF to that of the index. Hence, look for ETFs with a low tracking error.
Remember, the hallmark of a successful investor is knowing the investment options available and working on an investment plan based on the financial goals, time horizon, and risk tolerance. Before you start looking for an ETF to invest in, ensure that you have an investment plan in place and understand the intricacies of an ETF. Since these funds are passively managed, they are designed to match the returns offered by the index and not beat them. Hence, keep your expectations real. Also, if you are an aggressive investor/trader, then you might want to dedicate a small portion of your portfolio to ETFs for stability. Think wisely and invest carefully.
Investment in securities market are subject to market risks, read all the related documents carefully before investing. Please read the Risk Disclosure documents carefully before investing in Equity Shares, Derivatives, Mutual fund, and/or other instruments traded on the Stock Exchanges. As investments are subject to market risks and price fluctuation risk, there is no assurance or guarantee that the investment objectives shall be achieved. NBT do not guarantee any assured returns on any investments. Past performance of securities/instruments is not indicative of their future performance.