Educating Investors

What are Exchange Traded Funds (ETFs)?2 min read

What are Exchange Traded Funds?

Exchange-Traded Funds (ETFs) are a type of pooled investment funds which invest in diversified securities such as equities, bonds, commodities that track an underlying index. Most of them are registered with SEBI.

Types of ETFs

There are various types of ETF available for Investors they are:

  1. Bond ETFs: These include government bonds, corporate bonds, and state and local bonds—called municipal bonds.
  2. Industry ETFs:  These ETFs track a particular industry such as banking, technology or the oil and gas sector.
  3. Commodity ETFs: These ETF’s invest in commodities including crude oil or gold.
  4. Currency ETFs:  You can invest in foreign currencies such as the Euro or Canadian dollar.

How ETFs work?

ETFs have common features of both shares and mutual funds. They are generally traded in the stock market in the form of shares produced via creation blocks. ETF funds are listed on all major stock exchanges and can be bought and sold as per requirement during the equity trading time.

The Price of the ETFs vary as per the asset classes in the ETFs, the price of the ETF would rise if the price of one asset class rises, and vice-versa.

Advantages of ETFs

  1. Cost Efficient: The biggest advantage of investing in ETFs is their cost-efficient. The expense ratio of an ETF is usually less than 0.5% compared to 2-2.5% for actively managed equity funds. 
  2. Liquid: ETF can be bought and sold at any time in the day (during market) it is more liquid compared to other investment products such as mutual funds or PPF. 
  3. Transparent: As ETFs track an underlying index, you know beforehand which stocks it will hold and in what proportion. For example, the SENSEX is composed of the 30 largest listed companies in India by market capitalisation. An ETF tracking the Sensex will hold these exact companies and in the same weights as the Sensex. 
  4. No involvement of Fund Manager: Since an ETFs tracks an Index, it does not rely on active investment calls provided by a fund manager. Hence it is not affected by the errors that a fund manager might make. 

Disadvantage of ETFs

  1. Requires Demat and Trading account: Unlike Mutual Funds, ETFs requires a Demat and Trading account and cannot be traded without them.
  2. Trading costs: If you invest small amounts frequently, there may be lower-cost alternatives investing directly with a fund company in a no-load fund
  3. Tracking error: While ETFs generally track their underlying index fairly well, technical issues can create discrepancies
  4. Settlement dates: ETF sales are not settled for 2 days following a transaction; that means as the seller, your funds from an ETF sale aren’t technically available to reinvest for 2 days.
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