An ETF, or exchange-traded fund, is a marketable security that tracks an index, a commodity, a bond, or a basket of assets like an index fund. In simple terms, ETFs are funds that track indexes such as CNX Nifty or BSE Sensex, etc. When you buy shares/units of an ETF, you are buying shares/units of a portfolio that tracks the yield and return of its native index. The main difference between ETFs and other types of index funds is that 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 they try to be the market. Unlike regular mutual funds, an ETF trades like a common stock on a stock exchange. The traded price of an ETF changes throughout the day like any other stock, as it is bought and sold on the stock exchange. The trading value of an ETF is based on the net asset value of the underlying stocks that an ETF represents. ETFs typically have higher daily liquidity and lower fees than mutual fund schemes, making them an attractive alternative for individual investors.
TYPES OF ETF:
| Index ETFs: These are funds that are designed to track a specific index. |
| Fixed Income ETFs: These funds are designed to provide exposure to nearly every type of bond available. ETFs are designed to provide exposure to a specific industry, such as oil, medicines, or high technology. |
| Commodity ETFs: These funds are designed to track the price of a certain commodity, such as gold, oil, or corn. |
| Style ETFs: These funds are designed to mirror a specific investment style or market size focus, such as large-cap value or small-cap growth. |
| Foreign market ETFs: These funds are designed to monitor non-Indian markets such as Japan’s Nikkei Index or Hong Kong’s Hang Seng Index. |
WHAT ARE THE BENEFITS OF INVESTING IN ETFs?
- Asset Allocation: Managing asset allocation can be difficult for individual investors given the costs and assets required to achieve proper levels of diversification. ETFs provide investors with exposure to broad segments of the equity markets. They cover a range of style and size spectrums, enabling investors to build customized investment portfolios consistent with their financial needs, risk tolerance, and investment horizon. Both institutional and individual investors use ETFs to conveniently, efficiently, and cost-effectively allocate their assets.
- Cash Equitation: Investors typically seek exposure to equity markets but often need time to make investment decisions. ETFs provide a “Parking Place” for cash that is designated for equity investment. Because ETFs are liquid, investors can participate in the market while deciding where to invest the funds for the longer term, thus avoiding potential opportunity costs.
- Hedging Risks: ETFs are an excellent hedging vehicle because they can be borrowed and sold short. The smaller denominations in which ETFs trade relative to most derivative contracts provide a more accurate risk exposure match, particularly for small investment portfolios.
- Arbitrage (cash vs. futures) and covered option strategies: ETFs can be used to arbitrage between the cash and futures market, as they are very easy to trade. ETFs can also be used to cover option strategies on the index.
POSSIBLE RISKS IN ETFs: Trading costs: If you invest modest sums frequently, dealing directly with a fund company in a no-load fund may be less expensive. Illiquidity: Some lightly traded ETFs have huge bid or ask spreads, which means you’ll be buying at the spread’s high price and selling at the spread’s low price. Settlement dates: ETF sales will not be settled for two days after the transaction; this implies that, as the seller, your money from an ETF sale is theoretically unavailable to reinvest for two days.
CONCLUSION: An ETF is a marketable security that tracks an index, commodity, bond, or basket of assets like an index fund. ETFs aim to replicate the performance of the index, not outperform it. They trade like a common stock on a stock exchange, with higher daily liquidity and lower fees. ETFs offer benefits such as asset allocation, cash equivalence, hedging risks, and arbitrage between cash and futures markets. However, they also have trading costs, liquidity issues, and settlement dates. ETFs are attractive alternatives for individual investors due to their lower fees and higher daily liquidity.