What are Exchange-Traded Funds?
Exchange-Traded Funds are securities traded in the market similar to stocks which track an index, group of same sector stocks, commodities, or bonds. In other words, Exchange-Traded Funds (ETFs) are those funds that track indexes such as Nifty 50, Nifty Next 50, Nifty small cap fund, etc. However, the difference between index funds and ETFs is that unlike index funds, ETFs do not try to beat the market or perform better than the market, instead, they replicate the market. ETFs are traded on the market just like stocks, where the value is determined by the underlying asset and price is determined by demand and supply which changes continuously throughout the market hours.
Who Manages Exchange Traded Funds and How?
ETFs are managed by a fund manager and they are managed passively. Whereas mutual funds are actively managed by a fund manager primarily to safeguard the investment and outperform the market.
The idea of ETFs is primarily to copy an index fund stock by stock and ratio by ratio which gives the same returns as the index. In this case, you do not need a fund manager to tell you which stock to buy, hold, and sell.
Because the fund is passively managed the management fee is quite low compared to a mutual fund fee which charges a high management fee, usually 1 to 2%, due to continuous changes in the portfolio in the aim to beat the market.
Cost of Investing in ETFs
When an investor buys an ETF, the costs incurred are similar to buying a stock such as brokerage charges etc. When it comes to mutual funds your expenses are paid by mutual funds but you pay a management fee which is higher than the ETFs.
ETFs are traded at much higher volumes because they represent a basket of stocks that is highly liquid and diversified. Unlike mutual funds which change price only after the closing bell, ETFs are priced continuously during the market hours.
Types of ETFs
Actively managed ETFs:
These are managed by a fund manager actively picking stocks for investors, which would cost more to the investors in terms of management fees.
Passive ETF:
These ETFs are trying to replicate a benchmark index or a sector index such as Nifty 50.
Bond ETF:
The primary aim is to provide investors with regular income. Bond `ETFs are the combination of certain types of bonds and the returns are based on the type and performance of different bonds such as government bonds, corporate bonds, etc. They do not have a maturity date, unlike bonds.
Stock ETF:
Stock ETFs are created by a basket of stocks related to the same industry or sector. The primary goal is to diversify and provide potential growth opportunities. Unlike mutual funds, stock ETFs do not charge much fees.
Industry or Sector ETF:
This focuses on a specific group of stocks operating in the same industry. Such as HDFC Nifty IT signifies Information technology stocks ETF.
Commodity ETF:
Invests in commodities such as crude oil, cotton, and others. The presence of commodity ETF in a portfolio hedges against the downturn of the market.
The ETFs market is worth more than 850 crores in the Indian NSE stock exchange as of 2024.
How to Invest in Exchange-traded funds?
It is really simple and straightforward to invest in ETFs nowadays. Almost every brokerage is providing services to buy, hold, and trade ETFs in the brokerage or trading account. All you need to do is to open an account with a popular brokerage in your area. Such as IIFL Securities or Interactive Brokers Ltd etc, whichever is suitable for your understanding.
Once you have an account loaded with cash in the trading account the second thing you need to do is find the best ETFs for yourself. Before getting to conclusions or believing some random website’s recommendations, try to research ETFs. By setting a filter or priority such as fee, past years performance, volume, liquidity, sector, etc.
Do ETFs give Dividends?
Of course, stocks do pay a dividend but when the stocks held by the ETFs pay a dividend they are reinvested.
Does an ETF give the same returns as an Index?
ETFs are supposed to mimic a benchmark index. However, there is a difference between the index and ETF portfolio return, this is called Tracking Error.
This occurs due to various expenses such as admin, management, marketing, and brokerage. Sometimes the ETF may outperform due to the dividend reinvestment. A well-managed ETF has low Tracking Error.