Passive investment is taking the investment world by storm. Globally, investors are starting to prefer passive investment strategies and passive funds overactive ones. There are many benefits that this offers, such as lower cost, better chances of long-term returns, etc. Here, we will talk about one such passive investment option, that is ETF or Exchange-Traded Funds.
What are Exchange-Traded Funds?
ETFs are mutual funds that are listed and traded on stock exchanges, just like shares. These funds pool money from investors and invest in diversified securities including equities, bonds, commodities, etc while tracking an underlying index.
An ETF tracks an index like the Sensex or Nifty by investing in securities in the same weights as the index. ETFs are tradeable in the market. An investor needs to have a Demat account for investing in an ETF and executing any buy or sell transactions.
Advantages of Investing in ETFs
Some of the known benefits of ETFs are:
- Low Cost
ETFs are preferred investment options because of their cost efficiency. The expense ratio of an ETF is often lower than 0.5% as compared to 2-2.5% that most actively managed equity funds charge. Lower fund management fee translates into incremental savings and therefore increased payouts for investors in the long-run.
ETFs are marketable securities that can be traded on registered indexes. Since these can be bought and sold at any time during trading hours, these offer higher liquidity in global markets when compared to regular mutual funds.
ETFs track an underlying index and the stocks held within the portfolio along with the proportion is known to investors. For example, the Nifty 50 comprises the 50 largest listed companies in India by market capitalisation. An ETF based on Nifty 50 will invest in these exact companies and in the same weights as the Nifty. The portfolio will also be rebalanced in case of changes in the index composition.
- No Manual Intervention
Since Exchange-Traded Funds track an Index, the fund manager’s investment decisions are not required. Therefore, ETFs are less affected by fund manager’s decisions or related errors. While these are prone to tracking errors, it can be usually ignored because of the quantum of impact.
Indian ETFs track diverse indexes such as Nifty, Gold, Nifty Next 50, Nifty Low Vol 20 Index among others. Active mutual funds rarely track such products.
Limitations of ETF Investment
Some of the drawbacks of ETFs are:
- Limited Chances of Outperforming the Market
ETFs do not aim to outperform the market since the idea is to passively track an index. An actively managed fund, on the other hand, has chances of generating higher returns than the index, especially in emerging markets like India.
- Limited Growth Opportunities
Since indexes like Nifty and Sensex mostly comprise mature companies, ETFs cannot tap the potential of companies that are in the growth stage and can generate higher returns, especially the ones in the small and mid-cap segments.
- Requirement of Demat and Trading Account
ETF investments require demat and trading accounts. Therefore, it may not be practical for investors who do not have these accounts. Mutual fund investors may not have such accounts as these are often not required for mutual fund investments.
Types of ETFs
Some of the common types of ETFs available for investment are:
- Equity ETF
These ETFs invest in shares of companies that are equity-focused. Equity ETFs also invest in other forms of equity of select organizations. Some of the recommended Equity ETFs are:
|Fund Name||Index Tracked||1- Year Returns||3-Year Returns||5-Year Returns|
|Nippon India ETF Nifty BeES||Nifty 50||69.04%||13.98%||15.16%|
|Nippon India ETF Bank BeES||Nifty Bank||99.04%||9.03%||15.28%|
|Motilal Oswal Midcap 100||Nifty Midcap 100||98.96%||11.34%||14.53%|
|Motilal Oswal Nasdaq 100||Stocks listed in the Nasdaq (US tech companies)||37.65%||26.94%||26.68%|
- Gold ETF
These are commodity exchange-traded funds that primarily focus on building a portfolio of physical gold assets. The investment strategy involves purchasing shares of companies that enable the fund to own gold on paper, without the risk of asset protection. Some of the top-rated Gold ETFs are:
|ETF Name||1 Year Returns||3 Year Returns||5-Year Returns|
|HDFC Gold Exchange Traded Fund||1.58%||14.37%||9.49%|
|UTI Gold Exchange Traded Fund||1.06%||14.38%||9.39%|
|Nippon India ETF Gold BeES||1.33%||14.43%||9.32%|
- Debt ETF
Debt ETFs are also known as Bond ETFs. These ETFs trade or invest in fixed return securities like debentures, government bonds, etc. Here is an example of a Debt ETF in India:
|ETF Name||1-Year Returns||3 Year Returns||5 Year Returns|
|Nippon India ETF Liquid BeES||2.15%||1.15%||1.02%|
- Currency ETF
Currency ETF funds aim to generate profits through exchange rate fluctuations. They invest in different currencies based on predictions about the currency’s future performance. Currency ETFs closely follow stock exchange trends along with political and economic scenarios of various countries. Here are two commonly traded Currency ETFs in India:
- Wisdom Tree Indian Rupee Strategy Fund
- Market Vectors- Indian Rupee/USD ETN
ETFs take the mutual fund features to the next level by offering flexible trading, higher transparency, and portfolio diversification. These are expected to grow in the Indian market over the next few years with increasing investor awareness and readiness to try newer investment options.
- Are ETF a good investment?
ETFs are slowly gaining popularity among investors who had preferred active fund investments. ETFs provide access to a variety of asset classes, different industries, and international markets. There are also risks attached to this investment mode that investors must carefully study before making an investment.
- What is the downside of ETFs?
Tracking error is one of the major drawbacks of ETFs as it can add to the overall cost for investors. Different ETFs may carry different levels of tracking error. Since ETFs mostly track an index performance, the fund’s returns may have lower chances of outperforming the index.
- Why ETF is better than stocks?
ETFs can be better than stocks since these provide exposure to a combination of stocks and sectors. In comparison, stocks limit an investor’s portfolio to specific sectors that may also increase the sector-wise risk within the portfolio.
- Are ETFs good for beginners?
Exchange-traded funds (ETFs) may not be suited for beginner investors since these are passive investments that require a certain level of knowledge of the markets and functioning or composition of the index chosen.
- Are ETFs good for long-term investing?
ETFs are ideal for long-term investing since there is very little turnover of the portfolio of underlying securities. ETFs can also be tax-efficient in the long run.