ETF Exchange Traded Fund

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