Indices like the Sensex and Nifty are representatives of the Indian stock market. Exchange-traded funds (ETF) are mutual funds of index funds that can be traded like stocks. ETFs are very popular in developed markets and have been part of the portfolio for investors since it was launched in 1990s. The Indian story is different though. ETFs are yet to capture the attention of investors in the Indian market. A lack of awareness of the intricacies of the product could be a reason.
ETFs are usually managed passively. Hence, the management fee is lesser than that of mutual funds, typically about 1% lower. The fund invests in an index, which comprises of a basket of securities. For example, Nifty ETF will invest in securities that comprise Nifty index and in the same ratio. Hence, the returns of the fund will follow the returns on Nifty. If the Nifty rises 50%, the returns on Nifty ETF will be 50% with marginal tracking error.
Types of ETF funds available
There are many types of ETFs available for investors in the Indian market. Some of them are:
Sensex or Nifty ETF: They track the performance of the Sensex or Nifty by investing in the securities, which are part of the Sensex and Nifty respectively and in the same proportion. Nifty BeES is an example of exchange-traded fund that tracks Nifty. Nifty Junior Benchmark Exchange Traded Scheme (Junior Nifty BeES) is another ETF that tracks stocks which are part of Nifty Junior Index.
Gold ETF: Gold ETF tracks the price movement of gold. For instance, Religare maintains a fund Religare Gold Exchange-Traded Fund, which tracks prices of Gold. Typically, one unit of Gold ETF corresponds to 1 gm or 0.5 gm of gold. Hence the price of one unit of gold ETF will be very close to the amount of gold underlying one unit. For example, the NAV of one unit of Religare Gold Exchange-Traded Fund is R2,576.09 clearly implying that one unit corresponds to 1 gm of gold. At the same time, the NAV of one unit of Quantum Gold Exchange-Traded Fund is R1,247, implying that one unit corresponds to 0.5 gm of Gold.
Sector-specific ETF: These ETFs track specific sectors by investing in a basket of securities from the sector. The performance depends on how the sector performs in the market. PSU Bank Benchmark Exchange-Traded Scheme is an ETF which tracks the performance of a basket of securities comprising public sector banks.
Liquid ETF: Liquid ETF invests in money market instruments such as treasury bonds, government bonds and call money market. This is almost risk free but the return is also low. Liquid BeES is one such fund.
Investing in ETF
Investing in ETFs is easy. They can be bought and sold just like stocks. Investors can use their regular demat account to buy and sell ETFs. The pricing of ETFs are tracked in real time just like stocks. You can place limit or market order too.
Important points
While ETFs track underlying index, commodity such as gold, or sector, the returns will not exactly match with the returns of underlying assets. There will be a certain degree of tracking error induced by management fee, brokerage charges, and keeping some cash component out of the investment.
ETFs are not yet popular in India. Hence, investors will find huge difference in liquidity of ETFs that are in the market. For example, Benchmark Nifty BeES enjoys high liquidity but Sensex Prudential ICICI Exchange-Traded Fund doesn?t have good liquidity. This means you cannot redeem few low-liquidity ETFs so easily. The fund houses come to the rescue of investors in such cases. They give investors option to redeem it through the fund house directly. Even though there are many ETFs following the same index or commodity, the returns could be different because of tracking error. Investors should invest in the one that is closest to the value of the underlying asset. For example, if gold price is R5,000 and two Gold ETFs show 4,090 and 4,095, select the one which shows 4095.
Finally, ETFs, which are passively managed, track an index. While this could be a good option in a bull market, the same can be detrimental to investors in bear market. In an actively managed mutual fund, the fund manager rejigs the portfolio to make the best out of situation. This is not an option in a passively managed ETF.
Final word
The question is whether you should have ETFs in your portfolio. The answer depends on how actively you want to manage the portfolio. For an active investor, the proportion in ETFs could be less. For a passive investor though, the proportion in ETFs can be more.
