• Investment
  • Car
  • Bike
  • Taxi
  • Term Life
  • Health
  • Travel

Exchange Traded Fund

Exchange Traded Funds (ETF) are classified under the mutual fund category and traded on a stock exchange. Exchange traded fund investments work similar to stock investments. Resultantly, its Net Asset Value (NAV) is not calculated at the end of each trading day as it is for mutual fund investments. This is because Exchange Traded Funds witness fluctuations in their prices throughout their purchase and sale. The underlying assets held by an exchange traded fund can be stocks, bonds, commodities, foreign currency, oil futures, etc.

The ownership of these underlying exchange traded fund assets is segregated by converting them into shares. Though these assets cannot be owned by shareholders, they can avail a specific percentage of the profits as interests or dividends. Similar to stocks, exchange traded fund units can be bought, sold and transferred.

Exchange traded funds closely assess the indexes like bond index or stock index like CNX Nifty or BSE Sensex. However, in contrast to other index funds, exchange traded funds do not make an effort to improve their performance in comparison to other corresponding index. They aim to replicate the performance of the corresponding index. Exchange traded funds are a wise investment option for investors as they offer high liquidity at low prices.

Types of Exchange Traded Fund

The following are the common types of exchange traded funds:

Index exchange traded fund

This is the most popular exchange traded fund. As evident from the name, it tracks the index performance with the objective of replicating it. It buys every stock available in the benchmark index in equal proportions and manages them passively, which involves lower expenditure. Some of the renowned index funds are IDFC Nifty Fund, UTI Nifty Index Fund, HDFC Index Fund, Aditya Birla SL Index Fund, IDBI Nifty Index Fund, SBI Nifty Index Fund, Reliance Index Fund, etc.

Stock exchange traded fund

This exchange traded fund investment offers investors the exposure to an extensive variety of equities in a specific index or sector, without having to purchase individual stocks.

Bond exchange traded fund

This exchange traded fund category, traded on a stock exchange, aims to replicate the returns of an index of bonds. They include exciting properties similar to that of equities. Bond exchange traded fund offer several benefits like transparency of prices, monthly income pay-outs, diversification, high liquidity and ease of trading.

Commodity exchange traded fund

As suggested by the name, this type of exchange traded fund invests in commodities like gold, silver and other precious metals. Gold exchange traded funds are classified under this category of exchange traded fund. Several commodity exchange traded funds nowadays administer the futures trading strategy.

Currency exchange traded fund

This exchange traded fund aims to seamlessly expose investors to the foreign exchange market and is priced reasonably. It effectively tracks behaviour of a particular currency in the foreign exchange market and streamlines processes to enable trading of currencies during the usual trading hours.

Actively Managed exchange traded fund

In this exchange traded fund, a fund manager drives decisions regarding the portfolio of the underlying assets. Though it is not accompanied by a benchmark index, the fund managers can implement changes in the allocations of sectors. When these exchange traded funds are actively managed, they attract a high expense ratio.

Inverse exchange traded fund

Also referred to as a Bear ETF or Short ETF, this exchange traded fund category are traded on a stock exchange. As suggested by its name, the returns that they attract perform inversely to their benchmark index. The returns are based on trading derivatives, short selling, etc.

Leveraged exchange traded fund

This exchange traded fund makes the best use of debts and financial derivatives to enhance the returns on underlying index. They are not considered to be a wise long-term investment option because they involve high risks.

Features of Exchange Traded Funds

The salient features of exchange traded funds are:

  • Though exchange traded funds are index funds, that is, their investments are made on an index, the expense ratio of exchange traded funds are comparatively lower than index funds.
  • Exchange traded funds are managed passively which implies that the fund manager does not have to track and manage them actively or decide on the stocks to invest in.
  • Exchange traded funds ensure a comparatively lower tracking error, which evaluates how closely the portfolio follows the benchmark index.
  • The trading value of an exchange traded fund is determined by the NAV of their underlying assets.
  • The primary aim of exchange traded funds is to attract high returns at nominal investment costs.

Benefits of Exchange Traded Fund Investments

Here are benefits that investors of exchange traded funds can make the most of:

  • To allow investors to take advantage of the prevalent price, exchange traded funds ensure purchases on the stock exchange and the ease of making intra-day sales at the existing price.

  • Exchange traded funds is an effective investment instrument that helps investors receive lucrative trading options by offering funds that track the performance of an index closely during the trading day. These funds can be purchased or sold as per the convenience of the investor.

  • Exchange traded funds are cost effective.

  • Exchange traded fund investments are aligned to allow authorised participants and large institutions generate new units and also exchange the remaining units with the fund, as opposed to listed close-ended funds that generally trade at discounts to NAV. This helps in ensuring that exchange traded funds can be traded at their original NAV as much as possible.

  • The exchange traded fund performance resembles that of index funds. The subscription and redemption of units functions with underlying securities and not with cash.

  • Exchange traded funds ensure a considerably higher reach and that too at lower costs. As these funds are listed on the stock exchange, the savings made on the distribution charges get shared with the investors through lower price quotes. The structure of exchange traded funds further brings down processing charges involved in collection, disbursement, etc.

  • Since exchange traded funds closely track transaction charges included at the time of purchase, subscription and redemption of index shares, long-term investors are saved from unnecessary inflows and outflows that are experienced by short-term investors.

  • Exchange traded funds serve as an efficient and flexible investment instrument for gaining immediate exposure to equity markets.

How Exchange Traded Funds Work

Exchange traded funds resemble a basket of assets or stocks and behave like the owner of assets underlying the fund. These assets include but are not restricted to stocks of companies, foreign currency, gold, oil futures and bonds. Since these funds can be purchased and sold on stock markets, similar to company shares, they resemble mutual funds in this regard. In India, index-linked and gold exchange traded funds are the most common classification under this investment category.

Exchange traded funds divide the assets it owns into smaller units, referred to as shares, which can be purchased and sold on the exchange. The existing trading value of an exchange traded fund is determined by the applicable value of net assets that the fund consists of at a particular point of time. For instance, in the case of a gold exchange traded fund, which majorly comprises of gold bullion as the underlying asset, fluctuations in gold prices immediately affects the price of gold exchange traded fund.

Contrary to company shares, shareholders of an exchange traded fund cannot stake claim to the underlying assets of that fund. However, these shareholders are eligible for profits earned from the underlying assets in terms of interests and dividends. The shareholders may also be able to avail a residual value in case of liquidation of the exchange traded funds.

Limitations of Exchange Traded Fund

The following will give you a fair idea of the limitations of exchange traded funds:

  • Exchange traded fund investments can be carried out through registered agents. However, these agents offer their expert services at a cost, which defeats the benefit of low expense ratio otherwise offered. Several investors prefer to follow the approach of making large one-off trades to avoid paying these extra charges. However, hiring an agent who charges reasonably may be a better alternative.

  • Exchange traded funds are vulnerable to volatile market situations like all other funds that are purchased and sold on exchange. This may adversely affect the investment value based on the direction of the change of price.

FAQs on Exchange Traded Fund

Are Gold ETFs a good investment?

Let’s have a detailed look at the benefits of gold exchange traded fund investments.

Healthy return on investment: The value of gold rarely depreciates. As gold mutual fund investments are linked to the market value of gold, they offer positive returns on investment, unlike other asset classes.

Hedge against inflation

Gold asset class is closely related to other asset classes like bonds and equity and remains unaffected during unstable economic situations like in inflation.

Safe and robust investment

The ability of gold to resist unstable capital market situations, along with appreciating value, makes gold mutual funds one of the safest investment instruments.

Diversification

Being a secure investment option, gold mutual fund give investors an opportunity to invest in a wider range of low-risk shares and stocks of gold manufacturers and miners to rebalance their portfolio. Demat account not compulsory: Gold mutual fund schemes offer exposure into gold as an asset class, even with a nominal investment amount, without having a demat account to invest through a mutual fund provider.

Systematic Investment Plan (SIP)

It encourages a disciplined investment approach over the long-term and ensures systematic investments in gold. It enables investors to plan the monthly expenses as per their investment and without ‘timing the markets’.

Liquidity

Gold mutual funds offer investors the benefit of redeeming gold funds on all business days, offering necessary financial support during emergency situations.

Cost-effective

Gold mutual fund enables investing small amounts, as per the convenience of investors. What makes it even more reasonable is that it does not involve extraneous expenses that are usually involved in other types of investments like annual maintenance charges for demat account , brokerage or delivery fees or transaction fees incurred for investing through the dematerialised mode, etc.

Tax Benefits

Gold mutual funds enable investors to avail long-term capital gains tax after remaining invested for a year. This is because it is treated as a non-equity investment from the tax perspective. In contrast, physical gold long-term taxation can be claimed only after 3 years since the investment.

Convenience of investing

Most gold mutual fund providers are equipped with service centres across locations in India to ensure easy accessibility and instant assistance.

Availability of add on facility

Add-on features like systematic transfer plan and systematic withdrawal plan are also offered on gold mutual funds.

Which one is better ETF or mutual fund?

The following will help you understand how exchange traded fund investments score over mutual fund investments:

  • Exchange traded funds trade actively during trading hours, while mutual funds trade at closing NAV
  • Exchange traded funds involve low operating expenses, while operating expenses vary for mutual funds
  • There are no limits on the investment value for exchange traded funds, while most mutual funds generally have investment minimums
  • Exchange traded funds are tax-efficient, while mutual funds are comparatively less tax-efficient
  • Exchange traded funds do not involve sales loads, contrary to mutual fund investments that might involve sales load

What is gold ETF scheme?

Gold Exchange Traded Fund (ETF), invests majorly in physical gold bullion . In other words, their underlying asset is physical gold bullion. Whereas a gold mutual fund invests in Gold ETFs which in turn invest in the bullion, the cost of the shares in these funds usually keeps up with the existing market price of gold.

Gold mutual fund is emerging as one of the leading mutual fund investment options. A distinctly unique feature that separates it from the other popular mutual fund categories is that while most mutual funds invest in stocks and other securities, gold mutual funds indirectly invest in physical gold assets.

Gold Mutual Funds in India are traded on the National Stock Exchange (NSE) and other globally renowned exchanges and function in a similar fashion as equity stocks of companies. This enables the units of gold mutual funds to be consistently sold and purchased on several international stock exchanges at the quoted market prices. The value of these mutual fund investments is closely linked to gold prices in the local or global markets.

This is a passive investment option that is best suited for individuals as well as companies that does not find purchasing physical gold a viable proposition or want to diversify their portfolio. Besides, it offers exposure to gold asset class, without the hassle of registering for a demat account. It is a safe investment instrument that remains mostly stable even during market volatility because gold prices seldom depreciate.

How do gold ETF work?

The objective of gold mutual fund is to replicate the performance of gold. Fund houses offering gold mutual funds manage their funds with the same aim. Authorised Participants (AP) are appointed by fund houses offering these mutual funds to purchase the units of these funds in lieu of physical gold assets. These participants are then involved in secondary market trading of gold. The underlying gold is controlled and managed by the fund house in the form of gold receipts or physical gold, giving it the ownership right.

The authorised participants can later decide to redeem the mutual fund units in exchange of the existing gold price. Gold mutual fund units can be purchased through a stock exchange that enables investors to purchase and sell gold units on a certain rate of payment as mentioned in the investment document. These authorised participants are usually leading financial institutions like market makers that are authorised with obtaining the underlying assets required to create, manage and run gold mutual funds.

Purchasing and selling of gold mutual fund units on the stock exchange does not create new units. New units can only be directly created with the fund house on the authorised participants appointed by the fund house in exchange of the underlying security with the gold mutual funds. The creation of new units leads to a rise in demand of physical gold.

The investment process for gold mutual funds is the same as that of stocks. As a result, they too experience price fluctuations during a trading day due to supply and demand. When several investors purchase gold mutual funds, their share price might rise above the NAV. Similarly, when many investors sell their gold mutual fund, the share price might experience a fall below its underlying bullion.

Gold mutual fund investments are greatly driven by the sentiment and psychology of investors. This is because they are bearish to lower prices and bullish to rising prices. Rising gold prices create great enthusiasm among gold mutual fund investors to purchase shares, which leads to a rapid increase in gold mutual fund share prices. Similarly, falling gold prices throw investors in a panic mode, making them sell their shares, which brings down gold mutual fund share prices.

The authorised participants purchase physical gold and deliver it to the gold mutual fund company in lieu of a block of gold mutual fund shares, referred to as a creation unit. The authorised participant may resell these shares for profits or redeem creation units to obtain the bullion, which again can be sold. Only authorised participants can redeem gold mutual fund shares, while retail investors can resell them in the open market. Whether it be securing, selling or reselling shares of gold mutual funds, share prices are determined by the actions and decisions of these authorised participants.

Are gold ETFS backed by physical gold?

Yes, certain Gold Exchange Traded Funds (ETFs) are backed by physical gold. However, contrary to popular belief, even if you have invested in physically-backed gold ETFs, it does not mean that you own physical gold. You cannot sell or redeem shares in lieu of physical gold.

What is ETF in stock market?

Exchange Traded Funds (ETF) are classified under the mutual fund category and traded on a stock exchange. Exchange traded fund investments work similar to stock investments. Resultantly, its Net Asset Value (NAV) is not calculated at the end of each trading day as it is for mutual fund investments. This is because Exchange Traded Funds witness fluctuations in their prices throughout their purchase and sale. The underlying assets held by an exchange traded fund can be stocks, bonds, commodities, foreign currency, oil futures, etc.

The ownership of these underlying exchange traded fund assets is segregated by converting them into shares. Though these assets cannot be owned by shareholders, they can avail a specific percentage of the profits as interests or dividends. Similar to stocks, exchange traded fund units can be bought, sold and transferred.

Exchange traded funds closely assess the indexes like bond index or stock index like CNX Nifty or BSE Sensex. However, in contrast to other index funds, exchange traded funds do not make an effort to improve their performance in comparison to other corresponding index. They aim to replicate the performance of the corresponding index. Exchange traded funds are a wise investment option for investors as they offer high liquidity at low prices.

Are ETFs a good investment?

Here are benefits that investors of exchange traded funds can make the most of:

  • Allows investors to take advantage of the prevalent price, exchange traded funds ensure purchases on the stock exchange and the ease of making intra-day sales at the existing price.

  • Exchange traded funds are an effective investment instrument that help investors receive lucrative trading options by offering funds that track the performance of an index closely during the trading day. These funds can be purchased or sold as per the convenience of the investor.

  • Exchange traded fund investments are aligned to allow authorised participants and large institutions generate new units and also exchange the remaining units with the fund, as opposed to listed close-ended funds that generally trade at discounts to NAV. This helps in ensuring that exchange traded funds can be traded at their original NAV as much as possible.

  • The exchange traded fund performance resembles that of index funds. The subscription and redemption of units functions with underlying securities and not with cash.

  • Exchange traded funds ensure a considerably higher reach and that too at lower costs. As these funds are listed on the stock exchange, the savings made on the distribution charges get shared with the investors through lower price quotes. The structure of exchange traded funds further brings down processing charges involved in collection, disbursement, etc.

  • Since exchange traded funds closely tracks transaction charges included at the time of purchase, subscription and redemption of index shares, long-term investors are saved from unnecessary inflows and outflows that are experienced by short-term investors.

  • Exchange traded funds serve as an efficient and flexible investment instrument for gaining immediate exposure to equity markets.

How does an ETF work?

Exchange traded funds resemble a basket of assets or stocks and behave like the owner of assets underlying the fund. These assets include but are not restricted to stocks of companies, foreign currency, gold, oil futures and bonds. Since these funds can be purchased and sold on stock markets, similar to company shares, they resemble mutual funds in this regard. In India, index-linked and gold exchange traded funds are the most common classification under this investment category.

Exchange traded funds divide the assets it owns into smaller units, referred to as shares, which can be purchased and sold on the exchange. The existing trading value of an exchange traded fund is determined by the applicable value of net assets that the fund consists of at a particular point of time. For instance, in the case of a gold exchange traded fund, which majorly comprises of gold bullion as the underlying asset, fluctuations in gold prices immediately affects the price of gold exchange traded fund.

However, contrary to company shares, shareholders of an exchange traded fund cannot stake claim to the underlying assets of that fund. However, these shareholders are eligible for profits earned from the underlying assets in terms of interests and dividends. The shareholders may also be able to avail a residual value in case of the liquidation of exchange traded funds.

What is an example of an ETF?

Some examples of exchange traded fund are:

  • Index exchange traded
  • Stock exchange traded fund
  • Bond exchange traded fund
  • Commodity exchange traded fund
  • Currency exchange traded fund
  • Actively Managed exchange traded fund
  • Inverse exchange traded fund
  • Leveraged exchange traded fund

What is an ETF and how does it work?

Exchange Traded Funds (ETF) are classified under the mutual fund category and traded in a stock exchange. Exchange traded fund investments work similar to stock investments. Resultantly, its Net Asset Value (NAV) is not calculated at the end of each trading day as it is for mutual fund investments. This is because Exchange Traded Funds witness fluctuations in their prices throughout their purchase and sale. The underlying assets held by an exchange traded fund can be stocks, bonds, commodities, foreign currency, oil futures, etc.

What is the difference between mutual funds and exchange traded funds?

The following are differences between exchange traded fund investments and mutual fund investments:

  • Exchange traded funds trade actively during trading hours, while mutual funds trade at closing NAV
  • Exchange traded funds involve low operating expenses, while operating expenses vary for mutual funds
  • There are no limits on the investment value for exchange traded funds, while most mutual funds generally have investment minimums
  • Exchange traded funds are tax-efficient, while mutual funds are comparatively less tax-efficient
  • Exchange traded funds do not involve sales loads, contrary to mutual fund investments that might involve sales load
Leave a rating!
5.0 (2 votes)