Investing in ETFs in India: A Beginner's Guide to Exchange Traded Funds

Exchange-Traded Funds were launched for the first time in the USA in 1993. Since then, they have gained popularity not just in America but also all over the world. Nifty BeEs is the first ETF that was launched in India in 2002. Since then, it has grown by 1914.15% (absolute returns). Nifty BeEs track benchmark index ‘Nifty’. Many investors are aware of stocks and mutual funds. But there is less awareness in the investor community about ETFs. 

In this article, we are offering you a beginner’s guide to ETFs.

What actually is an ETF?

An ETF is a mutual fund with few unique features. Like every mutual fund, an ETF collects money from investors, has a fund manager, and will have a NAV (net asset value). However, there are two features listed below that make them unique from regular mutual funds. They are:

• ETFs are traded on the stock exchange, but regular mutual funds are not.
• ETFs are passive mutual funds that usually track benchmark indices like Nifty or Sensex.

The fund managers of ETFs buy stocks of the benchmark indices and make sure that returns of the ETFs closely match with index returns.

Just like stocks, ETFs are listed on the stock exchanges. Investors can invest in them or trade using their stockbrokers. 

Now let’s go ahead and learn about the different categories of ETFs.

Period Invested For Absolute Returns 1 Year 46.40% 3 Year 47.93% 10 Year 285.84% Since Inception 1914.15%

Source – moneycontrol.com

P.S: You can now invest in ETFs on Groww!. All you need to do is, login to your account and enter the name of the ETF you want to invest in the search bar. You will be able to then place your order during market hours. With Groww, investors can check all information related to ETFs such as expense ratio, fund manager details, scheme objectives as well as track the live price of the underlying securities on-the-go. Please note, you will need a Demat account to start investing in ETFs on Groww. If you haven’t opened a Demat account on Groww yet, here’s how you can do so within minutes!

Read More: How to open a Demat account on Groww 

ETFs vs. Stocks vs. Mutual Funds

Now that you understand an ETF, its categories, and advantages, let’s take a look at a quick comparison between ETFs, stocks, and mutual funds:

ETFs Stocks Mutual Funds What is it? A basket of securities that tracks an underlying index or sector. Single security that signifies ownership in a company. An investment avenue where funds are pooled together and invested in different asset classes based on the objective of the fund. Risks A diversified approach to an asset class. Carries market-related risks though. Higher risks since the performance of the stock depends on that of the company. Diversified exposure but carries market-related risks. When can you trade? ETF units can be traded throughout the day. Stocks can be traded throughout the day. Mutual fund trades are fulfilled only once a day after the market closes. Control Less control than stocks but more than mutual funds. The most control over the investment. The least control over the investment.

ETF Categories

Exchanged traded funds are divided into four categories. They are:

Equity ETF

Gold ETFs

ETFs with International   Exposure

Debt ETFs

These ETFs try to track the performance of stock indexes or a group of stocks from a certain industry or sector. The goal of these ETFs is to mimic the performance of its benchmark index or any particular sector. Investing in gold is considered a good way to protect oneself from currency volatility and economic downturns. On the other hand, investing in real gold has several drawbacks, including security, quality, resale, and taxes. Gold ETFs are exchange-traded funds that invest in gold bullion and allow investors to incorporate gold in their portfolio without investing in actual gold. Some ETFs mimic the returns of foreign stock indexes. They provide investors access to foreign markets and allow them to participate in specific economies’ growth stories. Fixed-income assets can be purchased using debt ETFs. These are actively traded on the NSE. Debt exchange-traded funds (ETFs) are less expensive than debt mutual funds.

Advantages of ETFs

An ETF is a great method to diversify your stock investments. When you invest in stocks, you can only acquire a certain number of equities based on your investment corpus. As a result, picking the right stocks becomes critical. However, if you buy in an ETF that follows a sector or asset class, you receive exposure to a broader selection of assets, which diversifies and strengthens your portfolio. Here are some of the advantages of ETFs:

1. ETFs, like shares, can be easily traded on stock exchanges.
2. ETF units are exchanged at market values. So, you have the chance to benefit if market perception favours the sector/market that the ETF follows.
3. You may purchase and sell units at any time of day.
4. An ETF’s expense ratio is often lower than most traditional mutual funds (especially actively managed mutual funds).

How to Select an ETF for Yourself?

There are 4 aspects that should be checked before investing in an ETF. They are:

• ETF Category

The ETF categories are equity, gold, international exposure ETFs, and debt. You should research the category in which you want to invest. After selecting the category, look for the sub-categories. For example, if you choose to invest in the equity ETF category, the sub-categories for equity would be based on the capitalization, sectors, etc.

• ETF Trading Volume

Earlier ETF investors faced liquidity issues. But things have changed now. ETFs have gained popularity, and most ETFs have considerable liquidity, which makes buying and selling ETF units much easier. Still, a few ETFs have lesser trading volumes than others. In such ETFs, selling your existing units or buying new ones can be difficult because of liquidity. So, always choose an ETF with good trading volume.

• Expense Ratio

The expense ratio can eat your returns. To gain better returns, you should select an ETF with a lesser expense ratio than its peers.

• Tracking Error

ETFs are often created to track a certain index. They invest in securities that make up the index in such a way that the returns ‘closely match’ the indices. As a result, there is always a discrepancy between the index and the ETF returns. While selecting an ETF, choose one with a minor tracking error.

Key Takeaways

1. Unlike regular mutual funds, ETFs can be traded on the stock exchanges.
2. ETFs are passively managed funds that attract less expense ratio than regular mutual funds.
3. ETFs generally track a benchmark index or a particular sector.

FAQs on ETF Investment in India

What is Tracking Error?

The tracking error is a metric that measures the variation in the ETF’s performance compared to the underlying index. It is also known as the standard deviation of the index and ETFs daily return differences.

What is Expense Ratio?

The entire proportion of a stock or asset fund’s assets used for administrative, management, advertising, and other expenditures is known as the expense ratio.