Wondering where you had heard the term ETF recently? Well, the Government of India has taken the ETF route for disinvesting its holdings in public sector companies, instead of selling them in piecemeal tranches. The financial vehicle for this purpose is named Bharat 22 ETF, which puts 22 public sector companies on the market. So,
What is an ETF?
Exchange-Traded Funds are Mutual Funds that are listed and traded like stocks.
Institutional investors can create Index ETFs and list them on the market by swapping shares in an index basket for units in the mutual fund. ETFs do not require intervention from fund managers as they simply copy an index and reflect its performance. So, you can buy and sell ETFs at market price during trading hours. Here are some salient features of Exchange Traded Funds:
• An ETF is a basket of securities that trade on an exchange like a stock.
• ETF prices fluctuate as quantities are bought and sold, which is different from mutual funds that are only traded once a day after the closing of the market.
• An ETF can contain investment vehicles like stocks, commodities, or bonds.
• ETFs offer low expense ratios and lower broker commissions.
ETFs were initially used for tracking market bellwethers but nowadays are used for tracking different asset classes through custom-made indices. The efficacy of an ETF is measured through Tracking Error, i.e. the measure of how closely the ETF tracks its chosen index.
The Bharat 22 ETF, mentioned earlier in the article, is a financial vehicle that allows the Government to club its PSU holdings for raising money from investors in one go. The ETF tracks a custom-made S&P BSE Bharat 22 Index, made up of 22 PSU stocks and a few private sector companies.
Why are ETFs becoming the preferred choice of global investors?
First and foremost, ETFs are cost-efficient in comparison to stocks. While it would be expensive for an investor to buy all the shares held in an ETF portfolio individually, they need only one transaction to buy or sell an ETF. Thus, leading to fewer broker commissions and a lower expense ratio. The Bharat 22 ETF, for example, initially had an expense ratio of 0.0095 per cent, which is way lower than an actively managed fund that charges anywhere between 2.5 to 3.25 per cent per annum. Besides, some online trading platforms and stockbrokers even offer no-commission trading on certain low-cost ETFs.
Secondly, ETFs offer a diversified investment portfolio while allowing investors to avoid the risk of poor security selection by the fund manager. Stocks in the indices are carefully selected by index providers and are rebalanced periodically. Lastly, unlike mutual funds, ETFs can be liquidated any time through stock exchange trading.
Tax benefit of ETFs
An ETF is more tax-efficient than mutual funds as the buying and selling occur through an exchange and the ETF sponsor doesn’t have to redeem shares every time an investor sells or issue new shares when an investor buys. Hence, ETF investments offer a very lucrative tax benefit over investments in a mutual fund as ETFs only incur a capital gains tax when you sell the fund.
The Bottomline
ETFs are fast becoming the preferred choice of global investors in a risk-averse market hit by COVID-19. The popularity of ETFs also stems from low fees and simple structure of the funds. ETF investments are also a good start for beginners looking to diversify their portfolio without too much market expertise. ETF tracking indices such as Nifty 50 index or Sensex index can help you test the waters before you start investing in earnest.