What is ETF? How different it is from Mutual funds?

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ETFs (Exchange traded funds) are similar to the Mutual fund but are traded on the exchange. It is a basket of securities that trade on an exchange just like a stock.

Most EFTs are passive and they closely track a particular index. In the USA, ETFs are most popular and play a major part of their market. The assets managed by ETFs globally amounted to approximately 6.18 trillion U.S. dollars, out of which 80_85% contributed only by the US markets.People of America use the ETFs for long term investing unlike in India it is mostly used for trading by retail investors. 

The Concept of investing in ETFs in India is in a very nascent stage.The market size of the ETF is around only 2 lakh crore compared to 31 lakh crore market size of Mutual Funds.The first ETF product was launched in India only around 2001, but fund flow of the ETF industry was very low till August 2015. The effective growth has happened only in the last five years mainly after permitting  the 15% fresh inflow of EPF  (Employees’ Provident Fund) to be invested in ETFs.

Difference between ETFs and Mutual Funds (MF) : 

  • Price fluctuation 

MFs have NAV ( Net asset value) which is calculated at the end of the day.If you invest any point of the time in the day you will get only the day end NAV. But in ETFs you can purchase at various points of the day during the market hours and make use of the market fluctuation. Intra day profits can be booked in ETFs which is not possible in the Mutual Funds.

  • Expense ratio and Other Charges :

AMC charges a fee for managing your money. This fee is referred to as the expense ratio and it is expressed in terms of percentage of the AUM (Assets under Management). 

Expense ratio in an Index ETF is much lower compared to any actively managed fund. Almost all index ETF would have an expense ratio around 0.5% and even below. However, there is a catch. Since ETFs are bought and sold on the exchange like any other stock, additional costs like brokerage, STT and statutory charges need to be factored in to get the correct picture. 

Exit Load – The fees you pay if you want to take your money out before the funds pre-defined time frame. In MFs it is usually 1%. ETFs do not charge any Exit load charges.

  • Systematic Investment Plan ( SIP )

SIP is the most preferred way of investing in Mutual Funds.This gives the added benefit of rupee-cost averaging which lowers your average cost of owning the units. But SIPs are not possible in the ETFs and investing has to be done manually which becomes a challenge from a long term investor perspective.

  • Liquidity 

Liquidity means the ability to buy and sell fast.Mutual fund redemption takes usually 1-2 days. In ETFs they have instant liquidity as they are created on the stock exchange. If there is a mismatch in demand and supply, liquidity can be created in ETFs easily by the authorised participants using ETFs creation and redemption process.

NOTE : ETFs run a higher risk of bid-ask spreads widening when markets get volatile.

Important things to consider before buying an ETF:

  • The quoted price of an ETF (NAV) on the exchange and fair price of the underlying stocks (iNAV) may be varying due to the bid- ask spreads. Buyers/Sellers should ensure that both the price should be close enough. 
  • iNAV provides an intraday indicative value of an ETF based on the market values of its underlying constituents. The value is calculated by the listing exchange and then disseminated to the public every 15 seconds. iNAV can be checked on the AMC website before executing the trade.
  • Always we should use Limit Order while selling/buying ETFs to avoid the order executing in various different prices due to liquidity.

In India not many varieties/types of ETFs are available as compared to Mutual Funds. This will change as the ETFs become more popular in the coming years.

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