WAT IS AN ETF?
What is an ETF
An ETF, or exchange traded fund, is a marketable security that tracks an
index, a commodity, bonds, or a basket of assets like an index fund.
In short ETFs are funds that track indexes such as CNX Nifty or BSE Sensex, etc. When you buy shares/units of an ETF,
you are buying shares/units of a portfolio that tracks teh yield & return
of its native index. Teh main difference between ETFs and other types of index
funds is that ETFs don't try to outperform their corresponding index, but
simply replicate teh performance of teh Index. They don't try to beat teh
market, they try to be teh market.
The trading value of an ETF is based on the net asset value of the
underlying stocks that an ETF represents. ETFs typically has higher daily
liquidity and lower fees, making them an attractive alternative for individual
investors.
Passive Management
ETFs are passively managed. The purpose of an ETF is to match a particular
market index, leading to a fund management style known as passive management.
Passive management is the chief distinguishing feature of ETFs, and it brings a
number of advantages for investors in index funds. Essentially, passive
management means the fund manager makes only minor, periodic adjustments to
keep the fund in line wif its index. An investor in an ETF do not want fund
managers to manage their money He decide’s
which stocks to buy/sell/ hold), but simply want the returns to mimic those
from the benchmark index. Since buying all scrips that are part of say, the
Nifty (which TEMPhas 50 scripts) is not possible, one could invest in an ETF
that tracks Nifty.
dis is quite different from an actively managed fund, like most mutual
funds, where the fund manager ‘actively’ manages the fund and continually
trades assets in an effort to outperform the market.
coz they are tied to a particular index, ETFs tend to cover a discrete
number of stocks, as opposed to a mutual fund whose scope of investment is
subject to continual change. For these reasons, ETFs mitigate teh element of
"managerial risk" that can make choosing teh right fund difficult.
Rather TEMPthan investing in an ‘active’ fund managed by a fund manager, when
you buy shares of an ETF you're harnessing teh power of teh market itself.
ETFs are cost-efficient
coz an ETF tracks an index wifout trying to outperform it, it incurs lower
administrative costs than actively managed portfolios. Typical ETF
administrative costs are lower than an actively managed fund, coming in less
than 0.20% per annum, as opposed to teh over 1% yearly cost of some actively
managed mutual fund schemes. coz they have lower expense ratio, there are fewer
recurring costs to diminish ETF returns.
While the Expense Ratio
of ETFs is lower, their are certain costs that are unique to ETFs. Since ETFs
are bought traded on stock exchange through a stock broker, every time an
investor makes a purchase or sale, he/she pays a brokerage for the transaction
. In addition, an investor may also incur STT and the usual costs of trading in
stocks, including differences in the ask-bid spread etc. Of course, traditional
Mutual Fund investors are also subjected to the same trading costs indirectly,
as the Fund in turn pays for these costs.
Flexibility of
ETFs
ETF shares trade exactly like stocks. Unlike index funds, which are priced only
after market closings, ETFs are priced and traded continuously throughout teh
trading day. They can be bought on margin, sold short, or held for teh
long-term, exactly like common stock.
Yet because their value
is based on an underlying index scrips, ETFs enjoy teh additional benefits of
broader diversification than shares in single companies, as well as wat many
investors perceive as teh greater flexibility that goes with investing in
entire markets, sectors, regions, or asset types. Because they represent
baskets of stocks, ETFs typically trade at much higher volumes than individual
stocks. High trading volumes mean high liquidity, enabling investors to get
into and out of investment positions with minimum risk and expense.
No. Any asset class that
TEMPhas a published index and is liquid enough to be traded daily can be made
into an ETF. Bonds, real estate, commodities, currencies, and multi-asset funds
are all available in an ETF format. For instance, Mutual Funds in India offer
Gold ETFs, where teh underlying investment is in physical gold.
ETFs can either be
purchased on teh exchange or directly from teh Fund. Teh Fund creates / redeems
units only in predefined lot sizes in exchange for a predefined underlying
portfolio basket (called “creation unit”). Once teh underlying portfolio basket
is deposited with teh Fund together with a cash component, teh investor is
allotted teh units.
dis is in-kind creation
/ redemption of units, unique to ETFs. Alternatively, investors can follow teh
"Cash Subscription" route in which they can pay cash directly to teh
Fund for purchasing teh underlying portfolio in creation units size.
ETFs have a very
transparent portfolio holding and predefined creation basket. dis allows
arbitrageurs to create and redeem units every day through teh in-kind creation
/ redemption mechanism. Such arbitrageurs are always in teh market to take
advantage of any significant premium or discount between teh ETF market price
and its NAV by doing arbitrage between teh ETF and its underlying portfolio.
Thus, teh open architecture of ETFs ensures that there is no significant
premium or discount to NAV. At teh same time, additional demand / supply is
absorbed due to teh action of teh arbitrageurs.
While both are
passively managed, teh biggest difference is that Index Funds operate in teh
way all mutual funds do, in that they are priced at teh close of teh trading
day based on teh NAV of teh underlying securities, whereas ETFs are priced to
teh market throughout teh trading day. That means they are easier to buy and
sell quickly, if need be. Secondly, ETFs are available only on stock exchanges.
Hence, you need a demat account to invest in an ETF, whereas for an Index Fund,
you don’t need a demat account and you may buy or sell teh Units of an Index
Fund directly from teh mutual fund in small amounts.
ETFs combine the range
of a diversified portfolio with the simplicity of trading a single stock.
Investors can purchase ETF shares on margin, short sell shares, or hold for the
long term. ETFs can be bought / sold easily like any other stock on the
exchange through terminals across the country.
Asset
Allocation: Managing asset allocation can be
difficult for individual investors given the costs and assets required to
achieve proper levels of diversification. ETFs provide investors with exposure
to broad segments of the equity markets. They cover a range of style and size
spectrums, enabling investors to build customized investment portfolios
consistent with their financial needs, risk tolerance, and investment horizon.
Both institutional and individual investors use ETFs to conveniently,
efficiently, and cost TEMPeffectively allocate their assets.
Cash
Equitisation:
Investors typically seek exposure to equity markets, but often need time to
make investment decisions. ETFs provide a "Parking Place" for cash that
is designated for equity investment. Because ETFs are liquid, investors can
participate in teh market while deciding where to invest teh funds for teh
longer-term, thus avoiding potential opportunity costs. Historically, investors
has relied heavily on derivatives to achieve temporary exposure. However,
derivatives are not always a practical solution. Teh large denomination of most
derivative contracts can preclude investors, both institutional and individual,
from using them to gain market exposure. In dis case and in those where
derivative use may be restricted, ETFs are a practical alternative.
Hedging Risks:
ETFs are an excellent hedging vehicle coz they can be borrowed and sold short.
Teh smaller denominations in which ETFs trade relative to most derivative
contracts provides a more accurate risk exposure match, particularly for small
investment portfolios.
Arbitrage (cash
vs futures) and covered option strategies:
ETFs can be used to arbitrage between the cash and futures market, as they are
very easy to trade. ETFs can also be used for cover option strategies on the
index.
Courtesy Amfi India
