What is Exchange Traded Funds (ETFS)?
Exchange Traded Funds (ETFs) are collection of various investment securites such as equities or bonds & It is traded on different exchanges much like stocks. In other word, an ETF is a basket of assets, such as stocks, bonds, or commodities, that tracks the performance of an underlying index or benchmark. ETFs offer investors a convenient way to gain exposure to a diversified portfolio of securities in a single transaction, with lower fees and greater liquidity compared to traditional mutual funds. ETFs are also known for their low expense ratios, which make them an attractive investment option for both individual and institutional investors.
In America, Exchange Traded Funds (ETFs) are designed to closely track the performance of an underlying index or benchmark, such as the S&P 500 or the NASDAQ, and can be bought and sold on stock exchanges throughout the day, just like individual stocks.
In India, Exchange Traded Funds (ETFs) track the performance of an underlying index, such as the Nifty 50 or the BSE Sensex, and offer investors an opportunity to invest in a diversified portfolio of securities in a single transaction.
What are the Types of Exchange Traded Funds?
There are several types of Exchange Traded Funds in world which include:
- Equity ETFs: These ETFs invest in stocks of various companies listed on a stock exchange. Equity ETFs can be further classified into broad-based ETFs, sector-specific ETFs, and country-specific ETFs.
- Fixed-Income ETFs: These ETFs invest in fixed-income securities such as bonds, treasuries, and money market instruments. Fixed-income ETFs can be further classified into government bonds ETFs, corporate bonds ETFs, and municipal bonds ETFs.
- Commodity ETFs: These ETFs invest in commodities such as gold, silver, oil, or agricultural products. Commodity ETFs can be further classified into physical commodity ETFs and commodity futures ETFs.
- Currency ETFs: These ETFs invest in foreign currencies. Currency ETFs can be further classified into single currency ETFs and currency basket ETFs.
- Alternative ETFs: These ETFs invest in non-traditional assets like real estate, infrastructure, and private equity. Alternative ETFs can be further classified into real estate ETFs, infrastructure ETFs, and hedge fund ETFs.
- Leveraged and Inverse ETFs: These ETFs use derivatives to provide magnified or opposite returns to an underlying index. Leveraged ETFs aim to provide two to three times returns of an underlying index, while inverse ETFs aim to provide the opposite returns of an underlying index.
What is ETF investing?
ETF (Exchange Traded Fund) investing is a type of investment fund that trades on stock exchanges like individual stocks. ETFs can hold a diversified portfolio of assets, such as stocks, bonds, commodities, or a combination of these. ETFs are designed to track the performance of a specific index or benchmark.
ETFs are popular among investors because they offer several benefits, including diversification, flexibility, and lower costs compared to traditional mutual funds. ETF investing involves buying and selling shares of an ETF on a stock exchange, similar to how you would buy and sell individual stocks. Investors can use ETFs to build a diversified portfolio that tracks specific market segments, such as technology or energy, or to gain exposure to specific regions or countries. ETFs are a popular investment option for both individual investors and institutional investors, such as pension funds and hedge funds.
What are the Pros and Cons of Exchange Traded funds?
Despite all the attractions, Exchange Traded Funds (ETFs) have several pros and cons that investors should know before investing in them. Followings are some of the most important ones:
Pros:
- Diversification: ETFs offer investors exposure to a basket of assets, such as stocks, bonds, or commodities, which can help diversify their portfolios and reduce risk.
- Low Costs: ETFs typically have lower management fees than mutual funds, making them a cost-effective way to invest in a diversified portfolio.
- Liquidity: ETFs trade on an exchange like stocks, providing investors with easy access to buy or sell them at any time during market hours.
- Transparency: ETFs disclose their holdings daily, providing investors with greater transparency about the fund’s underlying assets.
Cons:
- Trading Costs: ETFs may incur additional trading costs, such as brokerage commissions, which can eat into investor returns.
- Tracking Error: The performance of an ETF may not perfectly track the performance of its underlying index or assets, leading to tracking errors and potential underperformance.
- Concentration Risk: Some ETFs may be heavily concentrated in a particular sector or asset class, which can increase risk if that sector or asset class experiences a downturn.
- Overtrading: ETFs’ low costs and liquidity may encourage overtrading, which can result in excessive trading costs and lower returns.
Examples of Exchange Traded Funds:
In America:
- SPDR S&P 500 ETF Trust (SPY): Tracks the performance of the S&P 500 Index.
- Invesco QQQ Trust (QQQ): Tracks the performance of the NASDAQ-100 Index.
- iShares Russell 2000 ETF (IWM): Tracks the performance of the Russell 2000 Index.
- Vanguard Total Stock Market ETF (VTI): Tracks the performance of the CRSP US Total Market Index.
- iShares MSCI EAFE ETF (EFA): Tracks the performance of the MSCI EAFE Index, which includes large- and mid-cap stocks from developed markets outside of North America.
In India:
- Nifty 50 ETF: Tracks the performance of the Nifty 50 Index, which represents the top 50 companies listed on the National Stock Exchange (NSE) of India.
- BSE Sensex ETF: Tracks the performance of the BSE Sensex Index, which represents the top 30 companies listed on the Bombay Stock Exchange (BSE) of India.
- Nippon India ETF Gold BeES: Tracks the performance of the domestic price of gold in India.
- ICICI Prudential Nifty Next 50 ETF: Tracks the performance of the Nifty Next 50 Index, which represents the next 50 companies after the Nifty 50 Index on the NSE of India.
- HDFC Bank Nifty 50 ETF: Tracks the performance of the Nifty 50 Index, which represents the top 50 companies listed on the NSE of India.
ETFs (Exchange Traded Funds) vs Mutual Funds vs Index Funds:
ETFs, mutual funds, and index funds are all types of investment funds, but they differ in several ways:
- Trading: ETFs trade like stocks on exchanges throughout the trading day, whereas mutual funds and index funds are priced and traded once a day after the market closes.
- Fees: ETFs and index funds generally have lower fees than actively managed mutual funds because they track an index rather than having a team of fund managers making investment decisions.
- Investment Minimums: Mutual funds and index funds often require a minimum investment amount, while ETFs typically do not.
- Tax Efficiency: ETFs and index funds tend to be more tax efficient than mutual funds because they typically have lower turnover and capital gains distributions.
- Diversification: All three types of funds offer diversification, but ETFs and index funds tend to offer broader diversification because they track a market index, whereas mutual funds may have a more focused strategy.
- Active Management: Mutual funds are actively managed, meaning that a fund manager makes investment decisions, whereas ETFs and index funds are passively managed and simply track a market index.
Who should Buy ETFs?
ETFs (Exchange Traded Funds) can be a suitable investment option for wide range of investors with different investment objectives and risk profiles. Followings are some groups of investors who may consider to invest in ETFs:
- Novice investors: ETFs can be an excellent investment option for novice investors because they offer instant diversification across multiple stocks, bonds, and other asset classes. Also, ETFs can be bought and sold like stocks, making them easy to trade.
- Passive investors: Investors who prefer to take a passive approach to investing can benefit from ETFs because they offer broad exposure to different markets and asset classes. Investors can also choose from a wide range of ETFs that track different indices, sectors, and regions.
- Active investors: Active investors who want to invest in specific sectors or regions can also use ETFs to gain exposure to those markets. ETFs offer an efficient way to invest in a specific sector or region without buying individual stocks.
- Long-term investors: Long-term investors who are focused on achieving their financial goals over the long term can use ETFs to build a diversified portfolio that is aligned with their investment objectives and risk profile.
- Investors with limited capital: ETFs offer an affordable way to invest in a diversified portfolio of stocks, bonds, or other assets. Investors can buy as little as one share of an ETF, making it an excellent option for those with limited capital.
Summary: In the simple terms, ETFs can be derived as funds that track indexes. When you are buying shares or units of an ETF, you buy shares/units of a portfolio that tracks the yield and return of its native index. The main difference between ETFs and other types of funds is, ETFs don’t try to outperform their corresponding index, but simply replicate the performance of the Index. They don’t try to beat the market; rather they try to be the market.
