What are ETFs?

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ETFs are fast becoming a popular choice for passive investors who would like to stay invested in the stock market without having to paying large fees to investment managers. One can think of an ETF as

  • a mutual fund that can be traded on the stock exchange as any stock
  • an index fund that tracks a popular index (Nifty 50, Junior Nifty, etc…)
  • a passive investment vehicle that doesn’t depend on a manager’s stock-picking ability

Essentially, an ETF will be a basket of stocks, much like a mutual fund. It will typically track an index with much lower fees compared to a mutual fund. And investors can trade in and out of ETFs on the stock market through their trading accounts.

Some of the popular ETFs in India are the NIFTYBEES (tracking the Nifty 50 index), JUNIORBEES (tracking the Junior Nifty) and the Bank ETFs KOTAKPSUBK & BANKBEES.

The three things to look out for while investing in ETFs is the total annual expense ratio (should be < 1%), tracking error (< 0.5% annualized) and liquidity (there should a fair amount of daily trading activity).

In the recent past, fund houses have tried to capitalize on sector specific ETFs with varying degree of success. For example, there are more than a dozen Gold ETFs listed in the NSE. However, the primary problem with commodity ETFs that don’t hold the physical underlying is that the tracking error tends to get compounded over a period of time and may not reflect the price actions accurately.

ETFs have traditionally worked great at tracking broad, liquid indexes and remain the preferred way to get passive market exposure.

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