Exchange traded funds or ETFs (as commonly known), are the mutual funds that can be bought and sold on the exchange. They are both passive and active. However, in India, they are generally, passive mutual funds.
However, unlike Index Funds, an ETF is listed on the stock exchange and can be bought and sold through a broker. You will need to have a trading account and a demat account. Index Funds can be bought/sold only from/to the Mutual Fund.
ETFs, come with several advantages over the index funds.
- Because of their structure, they have lower fees (typically around 0.5%) as compared to index funds.
- They allow you the facility of buying and selling the ETF at real-time prices during trading hours. Conversely, Index funds declare their price only once in a day at which they can be bought and sold.
- ETFs also have a lower Tracking Error. They track the returns of the underlying index better than Index Funds.
Though ETFs have a lower cost, they involve additional costs in the form of opening a demat account and the brokerage costs that need to be paid when you buy and sell an ETF. Index Funds are a choice for investors who do not have a demat account.
Why Invest in ETFs
ETFs allow long-term passive investors to diversify their portfolio instantly as they invest in the basket of securities. For shorter-term investors, they provide liquidity as investors can trade intra-day at prices near to the net asset value.
Investors also resort to exploiting arbitrage opportunities between spot prices, futures and ETFs. It gives investors better control and flexibility to manage their investments. ETFs have found favour with Institutional Investors also as a substitute for investing in Futures.
India joined the ETF club in December 2001 with the launch of India’s first ETF ‘Nifty BeES’ (Nifty Benchmark Exchange-traded scheme) by Benchmark Mutual Fund, based on S&P CNX Nifty Index. Since then a number of ETFs have been launched tracking different indices. Of late, Gold ETFs have become very popular in India because of its obvious advantages.