Exchange-traded funds (ETFs) are a popular investment tool especially among investors who seek a low-cost, diversified and passively-managed option of parking their money for the long term.In India, they have recently gained popularity but in western countries, the market for ETFs is large. In the US, as of 2020, $5.5 trillion is invested in ETFs. By comparison, as of July 2021, the market is around $44 billion in India.

What are ETFs?

To understand ETFs, let's review how a mutual fund works. A mutual fund pools money from investors, which is used to buy securities. Units of a mutual fund are distributed to investors, in line with their share of the pooled money. The fund company regularly publishes each unit's net asset value (NAV) in line with how the portfolio is performing.An ETF is essentially a mutual fund whose units are traded on the stock exchange. As opposed to buying mutual fund units from a fund company, ETF investors buy units from a seller on the stock exchange. The buyers and sellers determine the price of the ETF unit. These transactions cannot take place at a price that is too far away from the portfolio's underlying value. Any deviation creates a profit-making 'arbitrage' opportunity that closes the gap.There is another difference. Many mutual fund portfolios are actively managed. Through this approach, the fund manager hopes to beat the index. In contrast, most ETFs are passively managed. So its portfolio will have the same constituents as an index. Instead of doing better than the index, the ETF aims to reproduce its performance.

Types of ETFs in India

Index ETF: It usually tracks popular indices such as Sensex and the Nifty. This index can also follow sectoral indices like the Nifty Bank or Nifty IT. There are some ETFs that track foreign indices such as S&P500 and Nasdaq 100.
Gold ETF: As the name suggests, this ETF invests in gold. Its aim is to offer the same returns as the yellow metal. This is among the most popular and oldest ETF categories in India.
Debt ETF: A debt ETF tracks indices composed of government or corporate bond papers. A popular example is the Bharat Bond ETF.
Thematic ETFs: Thematic ETFs are track indices that are formed on special themes. Examples are Nifty50 Value 20, NIFTY100 ESG Sector Leaders, Nifty Quality 30, etc.
Others: Globally, there are a lot of other types of ETFs. These may be based on asset classes (commodities, currencies and even derivatives) or unique themes (such as artificial intelligence). Kristal.AI offers the opportunities to invest foreign-domiciled ETFs.

Should I invest in ETFs?

Investing in ETFs has several advantages.

Low cost: ETFs are some of the lowest cost investment products. Since a fund manager is not actively picking stocks to invest in, managing such funds is easier for the company.
Diversification: More often than not, ETFs invest in securities across industries, market cap and even asset classes. This protects your investment from volatility.
Passively-managed: Since these are passively managed, by design they ensure there is very low human intervention. This eliminates any biases that a fund manager may have.

ETF risks and return

Research shows most mutual fund schemes fail to beat their benchmarks. But, ETFs, by nature, deliver returns in proximity to the index. This is the reason legendary names like Warren Buffett and John Bogle have advocated for investing in ETFs.Apart from the market risk, liquidity can be another issue. Since ETFs are yet to be very popular in India, they may have low trading volumes. This may result in difficulty in selling or buying several ETF units. Some ETFs, especially in the midcap space, could have a bid-ask spread (or difference between buying and selling price) to the tune of 4-10% because of lack of liquidity.

How to invest in ETFs?

Buying an ETF is similar to buying a stock. If you have an account with a brokerage firm, you can call up your broker or place an online order.If you wish to invest in global ETFs through Kristal.AI, contact us.

Kristal Advisors

September 9, 2021

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