In the past few years, the ETF has captured a good amount of market share of the overall AUM of the mutual fund industry. It constitutes 13 % of the total AUM as per a study by Zerodha. This data is as of March 2024. The total AUM of the mutual fund industry as of March 2024 was ₹53 lakh crore, of which ₹6.95 lakh crore is through ETF. Earlier the ETF was not that popular and had too many liquidity issues, but now with the growing AUM, this hindrance of investing through the ETF seems to be dusted. SBI Mutual Fund, UTI Mutual Fund and Nippon India Mutual Fund are the top three AMCs which hold the maximum AUM in an ETF.
As an investor, it becomes of prime importance to know about the ETF and understand how investing through the ETF can play a pivotal role in generating good returns in the portfolio, fastening our journey towards wealth creation. So let's find out about ETFs, how they work, different types of ETFs and their benefits.
What are ETFs (Exchange Traded Funds)?
ETFs or “ exchange-traded-funds” as the name suggests are funds or baskets of securities created to monitor and replicate any specific index and can be bought and sold in market hours on exchanges. It gives you the flavour of mutual funds ( through a basket of stocks ) and equity ( which can be exchanged in stock markets). ETFs ( Exchange Traded Funds ) are the most important tool created in recent times for individual investors. Instead of buying a single stock, investors can invest in a basket of stocks thus reducing the risk as it provides diversification across stocks.
How does ETF work?
The ETF is managed by the asset management companies. Asset Management Companies generally roll out an ETF, which will have a basket of stocks based on market cap, theme or sector basis. The selection of stock is done based on the theme of the ETFs. The stocks in the baskets are owned by the ETF which are managed by asset management companies.
Let us understand this with an example, there is an existing ETF, UTI Nifty 50 ETF. Now this ETF is based on the NIFTY 50 Index. This ETF will replicate and hold the stocks which are there in the Nifty 50 Index. If there are any changes in the Index the same changes will be done in the ETF as well to replicate or mirror the index. To invest in this ETF ie UTI Nifty 50 ETF one has to buy it from the exchange and this will be held then held in the investor's demat account. The price of the ETF will keep on rising or falling in the market just like the price of stocks rises and falls in the market. At any given point in time one wishes to sell off this ETF, they have to place a sell order and the ETF will be sold off and debited from their demat account.
There are many ETFs available from which an investor can choose as per his risk appetite and horizon or if they feel a particular sector, industry or even theme is going to do good in future.
Let's look at different types of ETFs
Index ETFs ( Passive ETF ): This ETF is designed to monitor and replicate specific indexes. Here there is no involvement of the fund manager and the ETF will mirror the specific index. For Example UTI Nifty 50 ETF
Active ETFs: These ETFs are actively managed by fund managers and they will not be specific to any particular index but will be linked to a benchmark. It has the potential to beat passive ETFs but can be a little more expensive than passive ETFs.
Fixed Income ETFs: These ETFs will hold bonds which may include government securities, treasury bills, corporate bonds, state development loans and municipal bonds with different maturity and provide income to investors. There are now specific maturity-dated ETFs available for investors to invest as per their time horizon. For example Nifty G-sec June 2027 or Nifty 3-year SDL
Sector or Thematic ETF: These ETFs will hold stocks in their baskets which are specific to one sector or one theme. For example, an auto ETF will have stocks from automobile and auto ancillary industries whereas Electric Vehicle is a theme-based ETF which will have stocks from Auto, Auto ancillary, Energy, Infrastructure, Batteries and others supporting the theme. For example, Nippon India Nifty Auto ETF is a Sector ETF and will have stocks from a particular sector whereas Mirae Asset Nifty EV and New Age Automotive ETF is a thematic ETF and will have stocks which come under this category.
Commodity ETFs: These ETFs will hold commodities like gold or oil in the basket. It will track the price of underlying commodities like gold and oil. For example Nippon India ETF Gold BeEs.
Foreign Market ETFs: These ETFs will replicate and mirror international indexes such as Nasdaq 100, S&P 500, Japan’s NIKKEI Index or Hong Kong’s Hang Seng Index. For example Mirae Asset S&P 500 Top 50 ETF.
Style ETFs: Many ETFs will try to replicate even the style of investing like Large-cap Value or Small-cap Growth. For example Kotak Nifty 50 Value 20 ETF or HDFC Nifty Growth Sector 15 ETF
Inverse ETFs: These ETFs are designed to profit from the drop in price of the underlying market or index. Currently, there are no Inverse ETFs available in India.
Benefits of ETFs
Easy to Trade: Just like stocks, ETFs are tradeable on stock exchanges without any hassles.
Transparency: ETFs are transparent enough, you know what the basket of stocks ETFs are holding and the ETFs have to report their holdings daily.
Cost Efficient: ETFs are quite cost-effective compared to mutual funds where there is active management of stocks increasing the cost whereas most ETFs are passive.
Tax Efficient: Compared to mutual funds, ETFs generate less capital gains distribution.
An important point to note is that dividends declared in the ETFs are reinvested.
How to Invest in ETFs?
Step 1: Open your Demat account
Step 2: Select the ETF in which you want to invest
Step 3: Transfer the money
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