Invest In India » Index Funds

Exchange Traded Funds

Tushar Mathur — Tue, 11 Nov 2008 16:00:00 +0000

An exchange traded fund (ETF) is essentially an index fund that trades like a stock and is listed on the exchange. Although popular abroad, it’s still a new concept in India. Currently, India has 16 ETFs, with total assets under management of Rs 4,182 crore as of September 2008. In the US, by contrast, there are 707 ETFs, with combined assets of $585.9 billion or Rs 27.5 lakh crore.

An ETF is a single security representing a basket of stocks that corresponds to a particular index, say, the S&P CNX Nifty or Sensex. The ETFs trading value is based on the net asset value of the underlying stocks that it represents . Much like an index fund, an ETF offers built-in diversification . But because ETFs can be bought or sold within the trding day, they offer the flexibility of a stock. Like individual equity securities, ETFs are traded on a stock exchange and can be bought and sold throughout the day through a broker-dealer , just like Infosys or Reliance Industries shares.

Types of ETFs

ETFs can be broadly classified into index, commodity, and bond funds.

Most ETFs are index funds that hold securities and attempt to replicate the performance of a stock market index. An index fund seeks to track the index’s performance by holding either the contents of the index, or a representative sample of securities in the index.

Commodity ETFs invest in commodities such as precious metals and futures. In India, we only have gold ETFs.

As for bond ETFs, there is currently only one available in India, namely Liquid BeES.

There are other types of ETFs, such as currency ETFs and actively managed ETFs but they are not yet available in India.

No investment is perfect, but ETFs offer a broad range of benefits. They’re easy to trade, they offer diversification and depending on your situation, they might just be an attractive alternative to mutual funds and other investments.

Exchange Traded Funds (ETFs) are quickly becoming an alternative to mutual funds.

Disadvantages of investing in a Mutual Fund are:

Tushar Mathur — Thu, 16 Oct 2008 05:26:00 +0000
Mutual funds have their drawbacks and may not be for everyone:

No Guarantees: No investment is risk free. If the entire stock market declines in value, the value of mutual fund shares will go down as well, no matter how balanced the portfolio. Investors encounter fewer risks when they invest in mutual funds than when they buy and sell stocks on their own. However, anyone who invests through a mutual fund runs the risk of losing money.

Fees and commissions: All funds charge administrative fees to cover their day-to-day expenses. Some funds also charge sales commissions or "loads" to compensate brokers, financial consultants, or financial planners. Even if you don't use a broker or other financial adviser, you will pay a sales commission if you buy shares in a Load Fund.

Taxes: During a typical year, most actively managed mutual funds sell anywhere from 20 to 70 percent of the securities in their portfolios. If your fund makes a profit on its sales, you will pay taxes on the income you receive, even if you reinvest the money you made.

Management risk: When you invest in a mutual fund, you depend on the fund's manager to make the right decisions regarding the fund's portfolio. If the manager does not perform as well as you had hoped, you might not make as much money on your investment as you expected. Of course, if you invest in Index Funds, you forego management risk, because these funds do not employ managers.
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Advantages of Mutual Funds

Tushar Mathur — Thu, 16 Oct 2008 05:24:00 +0000

The advantages of investing in a Mutual Fund are:

Diversification: The best mutual funds design their portfolios so individual investments will react differently to the same economic conditions. For example, economic conditions like a rise in interest rates may cause certain securities in a diversified portfolio to decrease in value. Other securities in the portfolio will respond to the same economic conditions by increasing in value. When a portfolio is balanced in this way, the value of the overall portfolio should gradually increase over time, even if some securities lose value.

Professional Management:Most mutual funds pay topflight professionals to manage their investments. These managers decide what securities the fund will buy and sell.

Regulatory oversight: Mutual funds are subject to many government regulations that protect investors from fraud.

Liquidity: It’s easy to get your money out of a mutual fund. Write a check, make a call, and you’ve got the cash.

Convenience: You can usually buy mutual fund shares by mail, phone, or over the Internet.

Low cost: Mutual fund expenses are often no more than 1.5 percent of your investment. Expenses for Index Funds are less than that, because index funds are not actively managed. Instead, they automatically buy stock in companies that are listed on a specific index-

Transparency

Flexibility

Choice of schemes

Tax benefits

Well regulated

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Advantages and Disadvantages of ETFs

Tushar Mathur — Sun, 24 Aug 2008 15:03:17 +0000

This is the 2nd installment of our 2 part series on ETFs. Please read the first part here: Investing in ETFs

Advantages of ETFs

1. ETFs tend to be more cost-effective vis-a-vis comparable mutual funds. For instance, while the expense ratio of a passively managed ETF (tracking a benchmark index) would normally be in the range of 0.50%-1.00%; for an index fund, it can be as high as 1.50%.

2. Another important advantage with ETFs is that they provide more flexibility to investors than regular mutual funds. Since they are traded on the stock exchange, they are available to investors any time during the trading hours. So investors can buy and sell units of an ETF on a real time basis, unlike regular mutual funds, which can be transacted only at end-of-day NAV.

3. Since ETFs witness most of the buying/selling on the exchange, the interests of the long-term investor are not compromised. Take a regular equity fund where units are bought and sold at the AMC’s end – when a significant amount of money enters and exits the fund rather quickly, the long-term investor could suffer as a result of the costs (trading costs, registrar costs and opportunity loss, if the fund manager is forced to sell his best stocks) associated with this quick inflow/outflow.

With an ETF, since the trading investor does not approach the AMC at all and only interacts with other investors over the exchange, his quick entry/exit does not compromise the interests of the long-term investor.

4. Given ETFs are traded on the stock exchange, and can be bought/sold on a real time basis; they tend to have low tracking error (deviation of ETF’s performance from that of the underlying index) as compared to index funds.

Disadvantages of ETF

1. Investors need to have a demat and a trading account, with a SEBI registered stockbroker, for investing in ETFs. For investors, who do not trade in stocks, this could be a bit of a deterrent. Also, maintaining a demat account entails paying annual fees (approximately Rs 500), however the same varies across stockbrokers. For investors, who invest in stocks, this will not pinch as the maintenance charge of the demat account will be spread across the stock and ETF investments.

2. While investors have to incur entry/exit loads at the time of making/redeeming investments in mutual funds, for ETFs they have to pay a brokerage (usually around 0.50%) to the stockbroker, along with other applicable charges (STT for instance), every time ETF units are bought or sold. For a trader who frequently trades, this can have a significant impact on the net returns. But for long-term investors, these expenses hold little relevance.

What investors must do
It is evident that ETFs offer a different investment proposition vis-à-vis conventional mutual funds. ETFs may appeal to investors who want to track the performance of a particular benchmark index (such as S&P CNX Nifty or BSE Sensex); Similarly, the ETF route can also appeal to investors who are desirous of investing in asset classes such as commodities (e.g., gold), or even REITs (e.g., international real estate and homes). The allure of ETFs will only grow given the expanding bouquet of offerings.

Investors on their part would do well to thoroughly understand the pros and cons of ETFs; this will help them make informed investment decisions. Also, investors must consult their investment advisors/financial planners to determine the suitability of an ETF in their investment portfolios.

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