What are exchange traded funds and its types

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Exchange traded funds or ETFs are very popular investment option in mutual fund product space in the developed markets. In India too, it is gaining popularity and being compared with mutual fund investment due to its several advantages.

What is ETF?

Exchange traded fund invest in a basket of securities which replicate a particular index. For example, a BSE Sensex exchange traded fund will invest in all the 30 stocks in the same proportion which constitute the BSE Sensex Index.

Exchange traded funds are listed in stock exchanges and trade during the market hours just like shares. Unlike mutual funds the price of exchange traded fund keeps changing during the market hours. Whereas the mutual fund schemes NAVs are declared only after the market closure.

Different types of Exchange traded funds

There is a general perception that ETFs are limited to Nifty, Sensex and Gold. However, there are many types of Exchange traded funds. Below are some of the popular ETFs –

  • Stock Index ETFs: These are the most common type of ETFs and track stock indexes like Nifty, Sensex, Nifty Next 50, Nifty Midcap 150, BSE 500 etc.
  • Gold ETFs: The only commodity Exchange traded fund in India is the most convenient way of investing in
  • Sector ETFs: These are also stock ETFs but they track sector indexes like Bank ETF, Private Bank ETF, PSU Bank ETF, Midcap ETF, Small Cap ETF, Consumption ETF and IT ETF, etc.
  • Bond ETFs: They primarily invest in Government Securities, State Development Loans and PSU bonds etc. and track relevant indexes e.g. Bharat Bond Index, Nifty G-Sec Indexes etc.
  • International ETFs: These ETFs track international indexes.

Benefits of ETFs

  • Total Expense ratios (TERs) of Exchange Traded Funds are much less than TERs of actively managed mutual funds in India. Therefore, the return of ETFs can be higher compared to mutual fund investment over long investment tenures due to compounding.
  • There is no unsystematic risk in ETFs it has only market risks. As the Fund managers of actively managed mutual funds tend to be underweight or overweight on certain stocks / sectors compared to the benchmark index as an endeavour to generate alpha, they can have unsystematic risks in addition to the market risk. .

Important points to note when you invest in ETFs

  • ETFs do not aim to beat the market benchmark index; they only aim to track /replicate the performance of the index
  • The underlying portfolio of two Exchange traded funds from two AMCs tracking the same index will be same.
  • However, the TERs of two Exchange traded funds from two mutual fund houses tracking the same index can be different. Therefore, select ETF with lower expense ratio
  • You need to have a demat and trading account to invest in Exchange traded funds.
  • Unlike mutual fund investments where NAVs are declared at the end of the market hours, you can buy / sell ETFs at real time market price during the trading session.