Amazing Facts about ETF Investment Option on stock exchange
Do you want to go through the tens and thousands of stocks singlehandedly to pick and choose from and then decide which one to pick for your next stock market investment in India?
You cannot agree more that this is a tedious and cumbersome task to accomplish. Still, you will find people doing this. That is because, either they are not aware of the introduction of ETFs (ETF Full form Exchange-Traded Funds) or just not interested to know more about this beautiful stock market option.
They do not know what they are missing. I do not want you to fall in the line; hence I picked up this job of writing about ETF. So, here we go.
How about getting all blue-chip stocks traded together instead of doing it individually?
How about someone taking all the pain for you to select the top-notch stocks and putting them together in one basket so that you trade-in with the basket and not the individual stocks? Sounds crazy?
Is there a Good Samaritan in this diabolic world of ours? If there is one, why would he/she take up this painstaking process to select the best stock someone else?
The answer is, yes, there is someone who would willingly take this up for you, and only for dear. He is none other than our own Government of India.
And he is doing it for him and not for you rather for himself.
That is because; government is in need of money. They want to raise money by disinvestment.
The government discussed this in a meeting that he needs money to be raised from the market. How to do that?
A smart Alex from the committee who was present in the meeting (assuming) suggested the government walk the mutual fund way but not actually mutual funds.
So what is it then? Government asked this question to Alex who is smart.
This smart cookie suggested why do not we use the best of our own PSUs and put their stocks in a basket, which are doing fairly well, Let’s put all of them together and make one basket of stocks.
This will offer profitability and security to investors.
And what’s more? We will offer these stocks at a discounted rate than the market.
The government jumped on its chair and uttered: “That is it”. That’s a great idea. Let’s do it.
And, under the thundering sky, turbulent ocean, shattering earth, ominously looking surroundings, the title card scrolls up in slow motion,
The Bahubali of Stock Market, “THE ETF”
This is how ETF came into existence. Do I need to define ETF for you now, after the abovementioned long explanation? I do not think that is required.
ETFs are considered the next popular digression from Mutual Funds. ETF full form commonly used as Exchange-Traded Fund that is traded on an exchange similar to how you trade in stocks.
ETFs are primarily Index Funds that are listed and traded like stocks on an exchange. This was not quite possible before the advent of ETFs.
An ETF is a hand-picked combination of stocks holding a composition of an Index, for example, Nifty or BSE Sensex. The ETFs trading value is derived from the closest NAV of the underlying representing stocks.
ETF, although similar to Mutual Fund in as much as, you can buy and sell in real-time at a price that keeps changing throughout the day but they are not the same.
It is an investment fund traded on the stock exchange and combines stocks, commodities, or bonds at a certain ratio as deemed fit by the investor.
ETFs track an index that could be a stock or bond index. It may comprise a combination of bonds, stocks; gold bars, etc., and divides ownership into shares that are held by shareholders.
Exchange-Traded Funds (ETF’s)
In present times Exchange-traded funds (ETFs) have been accepted as financial instruments. This is due to the clear advantage that they have over mutual funds.
Beginners who are looking for their initial investments but finding it difficult to master the tricks of the trade to choose the right stocks to build a robust portfolio, ETF for them to begin with.
Some mutual funds are part of with ETF portfolio that attempts to mimic the indices on NSE to provide returns closely correspond to the total returns of the securities represented in the index.
ETF’s available on NSE are available in various categories and forms, such as Equity, Debt, Gold and International Indices ETF’s are available.
The current trading value of ETFs’ current trading value is calculated from the net asset value of the underlying stocks/ commodities that it represents.
ETF is suitable for risk-averse traders who find it difficult to identify stocks for their portfolio.
There are mutual funds for ETF investment products that attempt to replicate the benchmark indices on the BSE & NSE.
Why use ETF than shares?
ETF investments offer exposure to specific sectors. It is a combination of specific stocks, commodities and other relevant products, thus helping an investor diversify his/her investments.
ETFs are traded directly over the stock exchanges, where one can trade in ETF stocks at any point in time.
The ETFs call for lower expenses as compared to Mutual Funds due to several reasons
Both ETFs and Mutual Funds are listed on exchanges and ETF shares trade throughout the day just like an ordinary stock.
The price of an ETF’s shares changes throughout the trading day as the shares are transacted on the stock market. ETF combines multiple underlying assets and not one stock. As it holds multiple assets within its portfolio, ETF can be an attractive choice for investors who look for diversification.
The major benefits of ETF investments and ETF trading are ETF stocks provide diversification with liquidity at a lower cost. You can simply buy or sell ETF, just like buying or selling a stock.
Important things to know about ETF
ETF meaning an exchange-traded fund is a specific combination of securities that trade on an exchange, just like a stock.
Various types of ETFs
- Bond ETFs combines municipal bonds, such as government bonds, corporate bonds, and state and local bonds
- Industry ETFs is industry-specific and invest in sectors such as technology, banking, or the oil and gas sector
- Commodity ETFs focus on commodities that also include crude oil or gold
- Currency ETFs track and invest in foreign currencies such as the Euro or Canadian dollar
- Inverse ETFs help earn gains from stock declines by shorting stocks. Shorting is when you sell a stock expecting a decline in value and then repurchasing it at a lower price.
There are various categories of ETFs offered by the Indian Market, such as regular ETFs, Gold ETFs, Bitcoin ETFs, and CPSE ETFs.
Best ETFs to Invest in India
- Bharat 22 ETF
- Kotak Nifty ETF
- Motilal Oswal NASDAQ 100 ETF
- SBI gold ETF
- Reliance CPSE ETF
Buy and Sell ETFs
ETFs can be bought and sold through online brokers and traditional broker-dealers like Zerodha.
Upside and Downside of ETFs
For ETF trading, you only need to execute one transaction for buying and one for selling. We all know that Brokers will always charge a commission for each transaction. However, Brokers may help reduce your overall cost of transactions on a few low-cost ETFs by not charging a commission.
Typically, a more actively managed fund where involvement of money manager is high would call for a higher expense ratio than passively-managed ETFs where money managers are not actively involved in managing funds in your portfolio.
This will derive the expense ratio and weigh the costs vis-a-vis the ROI to ensure it is worth holding.
Dividends and ETFs
ETFs benefits can be two-fold. An investor can benefit from the prices of a stock rise and fall. Dividends are a part of earnings allocated or paid by companies to investors for holding their stock.
ETFs and Taxes
ETF is more tax-efficient investment instrument when compared to mutual funds.
ETFs Market Impact
Since ETFs are gaining immense popularity across investors, this has given an impetus to create many new funds further resulting in low trading volumes for some of them.
ETF Creation and Redemption
The supply of ETF shares is moderated using the mechanism of creation and redemption that involves large specialized investors, called authorized participants (APs).
Creation – Meaning and Definition
When ETF issues additional shares, AP buys shares of the stocks from the index tracked by the fund and sells or exchanges them to the ETF for new ETF shares at an equal value.
ETF’s launched on NSE
NSE Exchange-Traded Funds are typically Index Funds.
Advantages of ETFs
- ETFs offer exposure to an index or a group of securities that trade on the exchange similar to the trading of a single stock.
- While many investors have similar motives and approaches, no two are alike. That is where ETF succeeded.
- Since ETF is characterized typically by a unique structure, investors of all types, retail or institutional, long-term or short-term, are able to use it to their advantage without causing any disadvantage to others.
- ETFs, offer long-term investors options to diversify the portfolio at one go and at a lesser cost.
- This protects them from short-term trading activity due to the unique “in-kind” creation/redemption process.
- ETFs offer liquidity for investors within a shorter period of investment horizon as they can do intra-day trade and can have quotes near NAV during the process of the trading day.
- Consider a low initial investment, retail investors find it easy and simple to buy/sell when dealing in ETF.
- ETF enables easy asset allocation, hedging, and equitizing of cash at a lower cost for FIIs and institutional investors.
- They facilitate arbitrageurs to execute arbitrage between the Cash and the Futures markets at low impact cost.
- ETFs provide exposure to index or securities trading on the exchange as a single stock.
- ETF offers certain advantages over the traditional open-ended index funds which are as follows:
- Redemptions of Index fund units carried at a fixed NAV price determined usually the end of the day.
- ETFs provide the convenience of intra-day purchase and sale on the Exchange by taking advantage of prevailing prices to get as close as possible to the actual NAV of the scheme at any point in time.
- ETF offers investors a fund that closely tracks the performance of an index throughout the day with an option of trading at point of time during the day.
- They incur a low cost of transactions.
- These savings in cost translates into lower costs benefit passed on to the investors.
- The ETF structure facilitates a reduction in collection, disbursement and other processing charges.
- This is because the fund does not generate extra transaction cost for buying or selling the index shares due to frequent subscriptions and redemptions.
- Nifty BeEs (Nifty Benchmark Exchange Traded Scheme) or nifty ETF based on Nifty 50 were the first ETF in India launched in January 2002 by Benchmark Mutual Fund.
- You can buy or sell these ETFs like any other stock on NSE. Its symbol on NSE is “NIFTYBEES”.
Applications of ETFs
1. Efficient Trading:
Through ETFs, investors get a convenient way to gain market exposure since an index trades similar to a stock. As compared to stock, an investment in an ETF index product offers diversified exposure to the market. Investors may obtain exposure to countries/markets or sectors depending on the index,
2. Equitizing Cash:
Investors who are having large amounts of idle cash lying in their portfolios may invest temporarily in a product that is tied to a market benchmark like an index before deciding on the stocks to buy or to wait for the right time and price.
3. Managing Cash Flows:
Investment managers controlling the cash flows by managing inflows and outflows may use ETFs to capitalize on their liquidity and their ability to represent the market.
4. Diversifying Exposure:
If an investor is confused about the stock he/she should go for but likes the overall sector, investing in shares tied to an index or group of stocks provides diversified exposure and reduces stock-specific risk.
5. Filling Gaps:
ETFs associated with a specific sector or industry can help gain exposure to new and important sectors.
6. Creations & Redemptions
ETFs are different from Mutual funds. Unlike Mutual funds, ETF units are not sold to the public for cash.
The number of outstanding ETF units is not limited as compared to traditional mutual funds.
The “in-kind” creation/redemption facility enables ETFs to trade close to their fair NAV value at any given time. The individual investors purchase them just like any other shares on the exchange.
ETF units are created and redeemed continuously guided by investor demand. Investors may choose to use ETFs for investment, trading or arbitrage at their discretion.
ETF price tracks the value of the underlying index. This provides an opportunity for investors to compare the value of the underlying index against the price of the ETF units prevailing on the Exchange.
On the contrary, if the price of the underlying stock is below that of the ETF, the investors may add more ETF units by adding the low-priced securities.
This is called an arbitrage mechanism that removes the problem which is associated with closed-end mutual funds, namely, the premium or discount to the NAV.
ETF vs Mutual Fund
ETFs offer a higher degree of flexibility as it can be traded as usual stocks. The same degree of flexibility is no available in the traditional mutual funds. More importantly, investors offer trading of ETFs throughout the trading day as in stocks.
Another major difference that makes ETF an attractive investment proposition is that the investors can purchase units of the traditional mutual funds only at the fund’s NAV, which is published at the end of each trading day while investors cannot purchase ETFs at the closing NAV.
This difference is an important advantage of ETFs over traditional funds. ETFs are immediately tradable and hence, the risk of the price differential between the time of investment and time of trade is significantly less in the case of ETFs.
ETFs are less expensive than traditional mutual funds and index funds as they cost lesser fees that get paid to manage funds. However, while investing in an ETF through a broker, a commission may be charged.
Use of “in-kind” creation/redemption facility combined with the low expense ratio, ETF’s tracking error is generally lower than traditional index funds.
Commodity ETFs are no different from other ETFs that invest in securities; they are not investment companies under the act of Investment Companies of 1940.
ETFs cost lower than traditional mutual funds. This is evident as ETFs generate a lower expense ratio. While ETF has lower expense ratios, it does not call for investments in cash or fund cash redemptions.
Mutual funds can charge fees ranging from 1% to 3%, or even more. Hence, when transactions have low or no-cost, ETFs become relatively competitive.
The cost difference is more pronounced if compared to mutual funds that incur the cost of a front-end or back-end load while ETFs do not have loading, be it entry or exit, whatsoever.
Examples of other fees associated with mutual funds that do not exist with ETFs are redemption fees and short-term trading fees.
ETFs are tailor-made to offer tax efficiency, hence can be increasingly attractive as compared with mutual funds.
ETF brings in is its stock-like features. Considering a mutual fund can only be bought or sold at the end of a trading day whereas ETFs can be traded during the period when the market is open.
For example, investors can short sell, use a limit order, use a stop-loss, buy on margin, and invest the money as per their choice or the funds available with them at a given point in time.
There is no requirement of minimum investment or a cap.
Among the Advantages of ETFs are the following:
ETFs offer low-cost investment because not all ETFs are actively managed by money managers. Also, ETFs are usually protected from the costs of trading in securities to accommodate purchases and redemptions of shareholders.
Buying and selling flexibility:
Another key advantage of ETF over mutual funds is that ETFs can be traded at current market prices at any time during the day when trading in the market is on, This is not the case for mutual funds and unit investment trusts. There are various measures of weighting the ETF.
Inverse ETFs derive profit from a price reduction in the value of the underlying benchmark.
SO Finally what have decided, be or not to be with ETF. No worries. Here are some tips at the grand Finale, of ETF discussion. To sum up, ETFs are nothing but a basket of blue chip, most sought after stocks, a mix from Maharatnas PSUs or private sector giants at a discounted price.
ETF hedges you from a bigger loss, also not for making a huge profit, you can play safe. It is lower cost option with relatively less expense ratios.
Great options for beginners for sure who are a bit confused about which stocks to choose to invest in.
ETFs trade throughout the day just like stocks and shares on the stock exchange and the price is determined dynamically by the market forces.
ETFs can be traded at any time and transparently as anyone can see the current price of the ETF.
What more do you want to play safe and make good profit with the discounted share price.
One disadvantage, you can change add modify or delete the stocks from ETF.
Let me tell you, all the earlier ETFs launched by the government have been a runaway success.
Q1. What is ETF Trading?
Exchange-Traded Fund (ETF) is a type of security that constitutes a collection of securities such as stocks.ETF tracks an underlying index. However, it can invest in any number of industry sectors or use various strategies.ETFs are primarily Index Funds that are listed and traded like stocks in an exchange.
Q2. Why use ETF than shares?
ETF offers Diversification. ETF investments offer exposure to specific sectors. It is a combination of specific stocks, commodities and other relevant products, thus helping an investor diversify his/her investments.
ETF offers Liquidity as in ETFs are traded directly over the stock exchanges, where one can trade in ETF stocks at any point in time. It is a low-cost investment option.
The ETFs call for lower expenses as compared to Mutual Funds due to several reasons. Direct and indirect costs (transaction costs, slippage, bid-ask spread, liquidity impact, opportunity costs, and market trends) do not exist in the simulated environment.
Q3. What are the types of ETFs?
Ans: There are primarily 4 types of classification of ETF. Bond ETFs, Industry ETFs, Commodity ETFs, Currency ETFs.
Q4. Which is cheaper ETF or Mutual Fund?
Mutual funds can charge fees ranging from 1% to 3%, or even more. ETF tracks index fund. ETFs expense ratios are about less than 1%. These cost differences can be significant in deciding which one to go for.
Q5. ETF or Mutual funds, which one is better?
The advantages of ETF over mutual funds are Lower costs, buying and selling flexibility, Tax efficiency, better Market exposure and diversification, Transparency, which are not available in mutual funds.