Exchange Traded Funds ( ETFs )

Exchange Traded Funds ( ETFs )

Mutual fund investors are consistently looking for diversification and access to multiple markets and asset classes. A solution is an actively managed mutual fund, in which a portfolio manager analyses and selects securities; tradable financial assets like stocks or bonds within a specific area of the market. Another option that a mutual fund investor can use is a passively managed exchange-traded fund (ETF) that tracks an index representing a specific area of the market. Over the last couple of years, innovative products have arisen that blend some of the benefits, and help circumvent some of the disadvantages, of each of these styles. They’re ETFs that incorporate fundamentals of active management, and have the prospective to deliver market similar growth within a lesser cost ETF structure. Exchange traded funds pool the monetary funds of several investors and use it to purchase various tradable financial assets such as shares, debt securities such as bonds and derivatives.

An ETF is a diversified basket of securities that track a particular index and is traded on an exchange like NSE in real time, just like an individual stock. Similarly, to any other stock, an ETF can be bought and sold throughout the trading day. Changes in the share price of an ETF depend on the prices of the underlying assets present in the pool of resources. If the price of one or more assets rises, the share price of the ETF rises respectively, and vice-versa. ETF listed on a stock exchange are subject to price fluctuations as per market trends. They are not stable like government bonds and trade at a profit or a loss depends heavily on the market state at that point in time.

All ETFs are registered with the Securities and Exchange Board of India (SEBI). ETFs are another choice for mutual fund investors with limited expertise in the stock market; instead of purchasing specific securities. ETFs share characteristic features of both shares and mutual funds. ETF funds are listed on all major stock exchanges in India and globally in real time and can be bought or sold in a similar manner. Also, like any other stock, an ETF can be purchased and sold throughout any trading session.

ETFs can be actively or passively managed, as per their type. Actively managed ETFs are operated by a portfolio manager, after carefully assessing the stock market and undertaking a calculated chance by investing in the companies with high potential for growth or momentum or value. Passively managed ETFs, on the other hand, follow the momentum trends of certain market indices, only investing in those index companies listed and following the fund flows trend into those companies.

ETFs are traded like stocks, just like stocks there are several expenses which have to be incurred to purchase or sell them. This is generally done by fund managers, who charge a nominal charge fee for such trades. You can also choose to execute trades by yourself on the stock market and not involve any mutual fund managers in the process. A demat account has to be opened in such a situation; operating a demat account requires some basic knowledge of stock market transactions and its associated procedures, which might be difficult for someone who is not familiar with trading.

So overall, ETFs of all types appeal to mutual fund investors who seek:

  1. Diversification
  2. Lower fees
  3. Transparency

Keep in mind that the advantage of lower fees is enhanced over time, so exchange traded fund investments with a longer time horizon are in the best position to benefit from ETFs. A financial advisor may be able to guide you about whether ETFs are a good fit for your monetary goals and the various choices to determine the sort or combination of ETF that are most suitable for your risk profile.

An important fact to note is that a passively managed ETF doesn’t attempt to exceed market returns; its aim is simply to replicate them, without a large management fee. In addition, indexes can get tilted towards company stocks trading at high inflated costs, and a passive approach does not correct these tilts in ETFs.

The information, analysis and opinions expressed herein are for education purposes only and are not intended to provide specific advice or recommendations. This material is not an offer, solicitation or recommendation to purchase any financial products or services. Always remember that all investments carry some level of risk, including the potential loss of principal invested.