Looking to invest in ETFs? An overview of different types of ETFs

Some of the most common assets considered by many retail investors are stocks, real estate, bonds, and gold. However, the concept of investing in various types of Exchange Traded Funds (ETFs) in general rarely finds any mention. Many stock investors with whom Ashwin, an investment banker, has interacted with, were clueless about ETFs despite being in the stock market for over a decade. Accidentally, one day, he came across a discussion meeting being held by the Brokers Forum of India where the topic was ‘ETFs and different types of ETFs’. It is at this point he decided to book his calendar to attend this discussion and speak up on ETFs to spread awareness about the instrument among different retail investors.

On the discussion day, he began by explaining what ETFs are. He said, “ETFs are exactly what their name suggests - baskets of stocks that are traded, just like individual stocks, on the stock exchange. An ETF generally tracks indices like Sensex, Nifty etc. In contrast to regular open-ended mutual funds, ETFs are structurally different. It is because in ETFs, asset management companies (AMCs) do not directly deal with retail investors as in case of mutual funds. Units get issued to some designated participants known as the APs or Authorized Participants. APs provide purchase and sale  quotes of ETFs on stock exchange, which allow retail investors to purchase as well as sell different types of exchange traded funds at any time when stock markets open for trading activities. Thus, ETFs trade just like stocks and witness changes in prices all throughout the trading day when they are purchased and sold.”

Ashwin then touched upon the background as well as the statistics part to enlighten investors about the inception of ETFs. He said, “The first modern day ETF S&P SPDR began trading in 1993 in the US. Since then, ETF markets in the US have grown tremendously. Currently, in the US market, there are over 2,000 ETFs listed. In India, on the other hand, though ETF initially was launched in 2002, it was not until the year 2015 that ETFs began gaining traction. Over the past 5 years, AUM for ETF has grown from Rs. 23,000 crore in April 2016 to around Rs. 3.5 lakh crore presently. In 2020, around the month of September, Nifty 50 ETFs’ AUM crossed the milestone mark of Rs. 1 lakh crore. Today, the mutual fund industry has over 100 different types of ETFs across 3 asset categories namely – gold, equity, and debt.”

Many investors, after knowing the stats, were both stunned and impressed with the instrument and requested Ashwin to highlight key benefits of ETFs before moving on with their types. Ashwin was extremely elated to get a positive response from them and quickly moved on to explaining their 3 crucial benefits.

Liquidity: One can purchase or sell an ETF at any time during a trade session. However, owing to their tradable nature, their unit price is prone to fluctuate throughout the trading day, unlike mutual funds where the NAV of the unit gets calculated just once a day.

Like stocks, ETFs are liquid in nature, which means one can simply sell or redeem their ETFs at any time. Liquidity in ETFs allows one to easily convert their investments into cash at times of instant monetary shortfalls or financial emergencies.

Cost effective: ETFs are extremely cost effective as compared to mutual funds, firstly due to their low expense ratio and secondly owing to the provision to buy and sell basket of shares in a single transaction. Expense ratio of ETFs are all time low as the funds mostly are passively managed; however, there are some actively managed ETFs too. On the other hand, as mutual funds are actively managed, they tend to have an expense ratio of usually 1 % to 2 % annually. Expense ratios of an ETF are usually as low as 0.05%. Also, in ETFs, one can sell and purchase a huge basket of shares in a single transaction, meaning investors save a lot on their brokerage charges.

Diversity: ETFs endow investors with a lot of diversity in their portfolio as compared to individual stocks. This diversification can assist an investor to reap huge benefits from growth of large sections of organizations. Also, this benefit dilutes the impact of sudden value erosion of stock the investor owns in their ETF basket.

Now, it was time to finally break down the different types of ETFs. Ashwin proceeded with this topic calmly to ensure that the types of ETF he explained were articulate and clearly understood by the listeners.

Equity ETFs

Equity ETFs invests in stocks of various indices which the ETF tracks. Essentially, they represent companies in different indices.

Gold ETFs

Gold ETFs aim at tracking physical gold prices and invest in gold bullion, and other gold related securities. In other words, gold ETFs are units that represent physical gold, which might be in a dematerialized form or paper. 1 gold ETF unit is equivalent to 1 gram of gold, which is backed by physical gold of the highest purity. Thus, gold ETFs combine the simplicity of gold investments and flexibility of stock investment, which permits the investor to become the owner of the gold with negligible burden to protect the asset.

International ETFs

International ETFs are investment products that permit domestic investors to get exposure of international indices. Such ETFs majorly invest in foreign based securities. Their focus can be global, regional, or on any specific country and might hold fixed income securities or equities.

Debt ETFs

Debt ETFs are investment instruments that permit investors to get exposure of fixed income securities like government bonds, debentures, etc. Such debt ETFs combine in the advantages of debt investments with flexibility acquired through stock investment and mutual funds simplicity.

Towards the end of the discussion, all the listeners were thoroughly clear about ETFs and their types and were anxious to invest in the kind that closely matched with their financial goals, risk appetite and investment horizon.




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