All you wanted to know about Exchange Traded Funds

| Updated on January 09, 2018

Lately, the Government has latched upon the Exchange Traded Funds (ETFs) route to disinvest its holdings in public sector companies rather than sell them on a piecemeal basis in the market. The latest such vehicle is the Bharat 22 ETF, a fund which houses 22 public sector companies, which is going to hit the market on Wednesday.

What is it?

Exchange Traded Funds (ETFs) are mutual funds listed and traded on stock exchanges like shares. Index ETFs are created by institutional investors swapping shares in an index basket, for units in the fund. Usually, ETFs are passive funds where the fund manager doesn’t select stocks on your behalf. Instead, the ETF simply copies an index and endeavours to accurately reflect its performance. In an ETF, one can buy and sell units at prevailing market price on a real time basis during market hours.

While ETFs originally tracked only the market bellwethers, they have evolved in recent years to track different asset classes. Many popular ETFs nowadays track custom-made indices as well. Apart from their returns, the efficacy of ETFs is measured through the Tracking Error, which measures how closely an ETF tracks its chosen index.

The Bharat 22 ETF to be offered now allows the Government to park its holdings in selected PSUs in an ETF and raise disinvestment money from investors at one go. It tracks the specially made S&P BSE Bharat 22 Index, managed by Asia Index Private Limited. This index is made up of 22 PSU stocks and with a few private sector companies.

Why is it important?

ETFs are cost efficient. Given that they don’t make any stock (or security choices), they don’t use services of star fund managers. In India, Nifty 50 and Sensex 30 ETFs charge annual expenses of 0.05 to 1 per cent of their Net Asset Value (NAV). But actively managed funds charge 2.5-3.25 per cent a year. Open-end index funds levy 0.20-2 per cent a year. The Bharat 22 ETF is quite a bargain too at an expense ratio of 0.0095 per cent, for three years from listing.

Costs apart, there are three reasons why ETFs are currently the rage among global investors. One, ETFs allow investors to avoid the risk of poor security selection by the fund manager, while offering a diversified investment portfolio. Two, the stocks in the indices are carefully selected by index providers and are rebalanced periodically. Three, ETFs offer anytime liquidity through the exchanges.

Why should I care?

Globally, ETFs have raced ahead of active funds in popularity thanks to their low fees and simple structure. If you are a newbie to equity markets, ETFs tracking indices such as Nifty 50 index or Sensex index can help you test the waters. This is indeed why the EPFO has chosen to route its maiden equity foray through a Sensex and Nifty ETF.

The Indian ETF universe is expanding. There are four types of ETFs already available — Equity ETFs, Debt ETFs, Commodity ETFs and Overseas Equity ETFs. Indian equity ETFs track the Nifty50, Nifty Next 50, Sensex 30, Nifty 100 and BSE 100, with select ETFs tracking mid-sized companies.

Thematic ETFs mimic indices that reflect a particular theme or sector. For instance, the Reliance ETF Shariah BeES tracks the Nifty 50 Shariah index — an index of companies compliant with the Islamic law. Debt ETFs track liquid fund returns and returns on the 10-year government security. Under commodity ETFs, Gold ETFs are the key category.

The bottomline

If you don’t want to put all your (nest) eggs in one PSU, you can now buy a basket of them through an ETF.

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Published on November 13, 2017

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