Exchange-Traded Funds: Types, Benefits and Returns

Mutual funds have been quite popular among investors and financial enthusiasts due to significant returns and benefits.

However, many individuals seek an alternative that requires low management fees and offers lucrative day trading opportunities.

Exchange-traded funds are an option that can help individuals fulfil their financial goals.

Keep reading to learn more about ETFs and how to invest in them.

What Are Exchange-traded Funds (ETF)?

An ETF or exchange-traded fund was introduced in 1993 as a basket of securities. These funds mirror the investment style of a popular index, such as Sensex and Nifty 50, and try to replicate the returns.

ETFs pool multiple investors' funds and invest them in tradable assets such as debt securities, bonds, shares, and derivatives.

These ETFs are registered with SEBI or the Securities and Exchange Board of India. Individuals can buy and sell ETFs on stock exchanges via a broker.

An interested investor can invest in multiple ETFs without any restrictions. Individuals looking to park their savings can easily invest during market hours. ETFs are highly liquid which allows investors to offload the units when necessary.

Individuals should have a clear understanding of ETF and their function to make an informed decision. In this regard, having an idea of the types of exchange-traded funds will be beneficial.

What Are the Types of Exchange-traded Funds in India?

Following is a table enlisting the different types of ETFs available in the market and their respective functions.

ETF Types	Function
Gold ETF	In Indian households, gold holds a significant worth due to its market value. Gold ETF allows investors to include gold in their portfolios without purchasing physical gold.
Equity ETF	These ETFs invest in stocks that constitute a particular index, for example, the S&P CNX Nifty and Nifty 50.
Currency ETF	Currency ETFs profit from fluctuations in exchange rates. The main objective of these funds is to monitor and take advantage of the price fluctuations of a specific currency or a collection of currencies.
Debt ETF	Debt ETfs invest in fixed income securities such as government bonds and debentures. Similar to equity ETFs, they track a particular index. That said, the indices comprise debt securities only.
International ETF	These ETFs track an international stock market index. By investing in them, individuals can explore foreign markets.

Now that you are aware of the different ETF types and what ETFs are, you must know how they work.

How Does an ETF Work?

ETFs are pretty similar to mutual funds in characteristics and function. However, as noted above, investors can buy or sell ETF units on stock exchanges (BSE, NSE, etc.) during market hours.

The price of the underlying assets in an ETF’s portfolio directly influences its net asset value (NAV). In other words, if the price of the stocks that an ETF invests in falls, the NAV of the ETF will also decrease.

Let’s check ETF benefits to understand this concept better.

What Are the Benefits of Investing in ETFs?

Here are some benefits of investing in the best ETFs in India:

Diversification: ETFs provide investors with diversification across various horizontals, including styles, sectors and commodities around the world.
Low-cost option: As per SEBI, the expense ratio cannot be more than 1% for ETFs, which is lower than the limit of actively-managed funds. Since ETFs are passively managed, the fund managers do not need to carry out thorough analysis and research. Hence, they charge low management fees.
Transparency: There is complete transparency with regard to the portfolio constituents of ETFs. These investment vehicles report NAV and holdings daily.

Once individuals know what exchange-traded funds are, they might want to check some of the best ETFs available in India along with their returns.

What Are the Returns on ETFs?

The table represents the 3-year returns of exchange-traded funds:

Exchange-traded Fund	3-year Returns
Motilal Oswal NASDAQ 100 ETF	40.68%
Nippon ETF Shariah BeES	23.27%
ICICI Prudential NV20 ETF	22.58%
Kotak NV 20 ETF	22.42%
Motilal MOSt Oswal Midcap 100 ETF	19.63%

*Returns as on 31st December 2021

Who Should Invest in Exchange-traded Funds?

The following can invest in ETFs:

Individuals seeking exposure to a particular currency, sector, asset class at a lower cost than actively-managed funds
Investors seeking diversification across different horizontals
Individuals looking to generate passive income

How to Purchase ETF Units?

Investors need to fulfil certain formalities to purchase ETF units without hassle. They have to have a Demat account with a broker to buy and sell the units.

Individuals wondering, “How can I invest in ETFs?” should consult a professional for suggestions. Ideally, there are two ways to invest in ETFs.

An individual can connect with a broker through call and place order and inform him/her about the buy or sell order.
One can also check the online trading terminals and place an order to purchase or sell ETF units.

However, before investing, individuals should check certain factors related to ETF for an informed decision.

Things to Consider Before Investing in ETFs

These are some factors that investors can consider before purchasing ETF units. This will help them make the most out of the advantages of exchange-traded funds.

Soft Impact Cost: It is an indirect expense of purchasing or selling a share. Here the impact price will be lower as an indirect cost to an investor will be less. There are chances of an increase in purchasing cost as underlying security prices fluctuate.
Liquidity: Liquidity is an essential factor that allows investors to sell and buy in a stock exchange. The ETFs with higher liquidity have a lower bid-ask spread. Comparatively, inferior liquidity would have a wider spread. Hence, it is beneficial to invest in higher liquidity ETFs.
Benchmark: Individuals should decide the sector or market segment they want to invest in. Depending on it, they can select the index to replicate. They can choose a sectoral ETF that focuses on stocks of a particular sector or a benchmark index.
Tracking Error: It is a typical deviation of the variance in returns between an index and ETF. Individuals should always opt for ETFs with lower tracking errors to achieve their investment objectives.
Expense Ratio: This is the yearly fee ETF charges to cover its expenses. These charges include management fees, operating costs, fund expenses, and asset-based costs.
AUM: Assets Under Management (AUM) refers to the overall value of the underlying financial instruments. An ETF’s AUM can change depending on the price of the portfolio constituents.

Individuals should know that exchange trade funds with higher AUM have higher liquidity.

These data are vital to understand exchange-traded funds and their operation. Individuals planning to invest in this fund should read the terms thoroughly or consult a professional for advice. This will help in making an informed decision.

Frequently Asked Questions

All

What is the function of NAV in ETFs?

ETFs are purchased and sold on the stock market. Here the prices fluctuate with market conditions. The NAV is reported after the market closes.

Can I invest in an ETF without a Demat account?

No, individuals have to open a Demat account to purchase ETFs.