In Exchange-traded funds (ETFs), money is pooled in from various investors and invested in a basket of monetary assets such as shares, debts, bonds, and derivatives.
Like index mutual funds, ETF track an underlying index like Nifty 50, gold, etc. However, unlike regular mutual funds, ETFs units can be traded like equities in the stock markets.
The growing awareness among investors caused a spectacular growth of ETFs in India, especially in the last five years.
Types of ETF in India
An ETF can be both actively or passively managed. While actively managed funds have a dedicated fund manager to make the investment choices, passively managed funds are automatically managed through specialized software and investment algorithms.
In India, an ETF can be of the following type depending upon the underlying asset involved:
- Hybrid ETF
Hybrid ETFs dynamically allocate and switch portfolio exposure between equity, gold, and debt depending on the market conditions. They aim to provide balance and stability to the investor’s portfolio while growing wealth in the long run.
- Gold ETF
A gold ETF in India tracks the physical gold prices in the country. Gold ETFs can provide higher liquidity in comparison to traditional gold investments.
- Bond ETF
Government and reputed corporate bonds can provide fixed and relatively less volatile returns. Therefore, risk-averse individuals may consider investing in Bond ETFs to prefer security over growth prospects.
- Sector Specific ETF
Sector-specific ETFs invest in equities solely from a specific sector. For example, a pharmacy sector ETF will invest only in pharmaceutical companies listed on the stock exchange.
Investors can choose such ETFs if they are optimistic about the future of a particular sector like banking, pharmacy, etc.
- Growth ETF
Growth ETFs invest in stocks of companies with potential for rapid growth. They are one of 2 broad categories of ETFs, the other being value ETFs. Investing in growth ETFs can provide high growth, however, they do tend to be high risk as the underlying stocks in the ETF growth portfolio tend to be highly volatile stocks.
- Value ETF
Value ETFs form baskets of undervalued stocks and aim to capitalize on the market’s underestimation of the intrinsic value of the stocks. A value ETF allows an investor to diversify funds across potentially undervalued stocks.
Factors Fuelling ETF Growth in India
Despite having their market presence in India since 2003, ETFs are left unnoticed by retail investors. However, perspectives are changing in recent times.
Phenomenal ETF growth in India was seen in recent years due to a combination of certain factors:
- Government Recognition as Asset Class
In the Union budget of 2013, the government recognized ETFs as an eligible asset class for the pension funds. In addition, the taxes on security transactions were lowered down.
- ETF Route for Disinvestment in PSEs
In 2014, the government made sincere efforts to disinvest in public sector enterprises through ETFs, which helped raise awareness on ETFs.
- Outperformance of ETFs
The top ETFs in India outperforming the regular funds in recent years developed a positive public perception.
Why Should You Invest in ETF
- Low Expense Ratio
ETFs have a relatively low expense ratio in comparison to regular mutual funds.
- High Liquidity
Buying and selling an ETF stock is very easy. The process is similar to transacting in equities.
- Greater Transparency
With real-time settlement and daily performance reports, ETFs provide a greater level of transparency.
- Diverse Option
As seen in the types of ETFs available in India, an investor can choose from a diverse range of ETFs as per the need, goal, and risk appetite.
- Stellar Growth
Since the last five years, the ETFs have delivered spectacular growth to investors. The best ETFs in India have managed to beat their referral indices since 2018.
The remarkable bounce-back of the Indian economy in the aftermath of the Covid-19, a resilient and robust stock market that was largely unaffected by the pandemic, and the increasing participation among the retail investors have contributed to the growth of ETFs.
The trends suggest that the years to witness the best growth in the ETF landscape are yet to happen. Therefore, an open eye and having exposure to ETF investment are advisable.WealthDesk democratizes wealth creation among retail investors. Curated by SEBI registered professionals, Our WealthBaskets provides the best mix of stocks and ETFs that helps in achieving your financial targets effectively.
A longer investment horizon can help you better tackle the short-term market volatilities. Furthermore, a low expense ratio can also help in maximizing your returns.
Tracking error is the difference between the actual performance of your fund with respect to the underlying benchmark it is following.
While the tracking error does not matter in actively managed funds, you should keep track of it in the case of passively managed funds.
Having said so, please note that tracking errors cannot be zero. A little amount of tracking error is normal.
ETFs are government-recognized investment instruments. Government organizations, like EPFO, routinely invest in ETFs. Furthermore, they are governed by the SEBI-defined norms and regulations.
Therefore, investments in an ETF are perfectly legal.
Exchange-traded funds, just like mutual funds, are market-linked instruments where your money is invested in the stock market. Therefore, your investments are subjected to the market performance and the associated risks involved.
However, they are known to beat inflation and outperform fixed instruments like bank FDs when invested for a longer duration.
While past returns can be one of the parameters to judge a fund’s performance, they should not be considered as a guarantee of good performance in the future.
ETF returns can depend upon a variety of factors, such as fund parameters, goals, objectives, the prevailing market conditions, the socio-economic outlook of the country, the government policies, etc.
Above all, consider the reputation of the fund house before taking the final call.