Exchange-Traded Funds (ETFs): Full Form, Types and Benefits

Home

Services

Products

Help

Get App

22 MAY, 2024

Exchange-traded funds (ETFs) offer the opportunity to gain exposure to a wide range of assets, including stocks, bonds, commodities, and currencies, in a cost-efficient and convenient manner. This post will break down what an ETF fund is, the different types of ETFs, and their unique characteristics.

What is ETF?

Exchange-traded funds (ETFs) are investment funds traded on stock exchanges, similar to individual stocks. They are designed to track the performance of a specific index, sector, commodity, or asset class. ETFs allow investors to gain exposure to a diversified portfolio of assets in a single trade.

By pooling funds from multiple investors, ETFs offer a cost-effective and efficient way to invest in a wide range of securities. The significance of ETFs in financial markets is evident in their ability to provide investors with instant diversification, liquidity, and transparency.

Types of ETFs

Regarding Exchange-Traded Funds (ETFs), several types cater to different investment objectives and strategies. One popular type is Equity ETFs, which expose investors to a specific stock market index or a basket of individual stocks. These ETFs allow investors to gain broad market exposure or focus on specific sectors, such as technology or healthcare.

On the other hand, bond ETFs invest in a diversified portfolio of bonds, providing investors with income and potential capital appreciation. Commodity ETFs track the performance of commodities like gold, oil, or agricultural products, allowing investors to gain exposure to these markets without owning the physical assets.

Sector ETFs focus on specific sectors of the economy, such as energy, financials, or consumer goods, providing targeted exposure to those industries. Lastly, International ETFs offer investors the opportunity to invest in foreign markets and gain exposure to international companies and economies.

How to Buy ETFs?

To invest in ETFs, you must understand the steps involved in making a purchase. The first step is to choose the right brokerage platform that offers a wide range of ETF options and provides a user-friendly interface for trading.

Once you have selected a platform, you must understand the ticker symbols associated with each ETF. Ticker symbols are unique codes representing a specific ETF used for trading purposes. To ensure accurate and efficient trading, familiarise yourself with the ticker symbols of the ETFs you are interested in.

Advantages and Disadvantages of ETFs

Advantages	Disadvantages
Diversification: ETFs provide an easy way to diversify your investment portfolio across various assets. This can help reduce risk by spreading investments.	Tracking Error: Sometimes ETFs may not perfectly replicate the performance of the index or asset they track, leading to tracking errors.
Low Expense Ratios: Compared to traditional mutual funds, ETFs typically have lower expense ratios, making them a cost-effective investment option.	Intraday Price Fluctuations: ETF prices fluctuate throughout the trading day, leading to potential volatility and uncertainty for investors.
Liquidity: ETFs are traded on major stock exchanges, similar to stocks, which means they can be bought and sold easily throughout the trading day.	Brokerage Fees: Buying and selling ETFs incur brokerage fees, which can add up and affect your investment returns, especially with frequent trading.
Transparency: ETFs offer transparency with their holdings, allowing investors to see which assets are currently in the ETF.	Limited Control Over Holdings: Investors in ETFs have no control over the individual holdings within the fund, limiting the ability to make adjustments based on personal investment criteria.

How Do ETFs Work?

The creation and redemption process is a key aspect of how ETFs work. ETF shares are created and redeemed through a mechanism known as the creation or redemption process. Authorised Participants (APs) play a crucial role in this process. APs are typically large institutional investors or market makers who can create or redeem ETF shares.

When an AP wants to create new shares of an ETF, they will gather a basket of assets that closely mirrors the composition of the ETF. This basket may include a combination of stocks, bonds, or other securities. The AP then delivers this basket of assets to the ETF issuer in exchange for newly created ETF shares.

Conversely, an AP can initiate the redemption process if they want to redeem their ETF shares. They will deliver a specified number of ETF shares back to the issuer and, in return, receive the underlying assets held by the ETF. This allows APs to efficiently enter or exit their positions in the ETF, ensuring that the ETF's market price remains closely aligned with its underlying assets.

What is an ETF Account?

An ETF account is a type of investment account that allows individuals to invest in exchange-traded funds (ETFs). ETFs are investment funds that trade on stock exchanges, similar to individual stocks. They are designed to track the performance of a specific index, sector, or asset class.

Opening an ETF account is a straightforward process. It typically involves selecting a brokerage firm or financial institution that offers ETF trading services. Once you have chosen a provider, you must complete an application form and provide the necessary identification and financial information. The account can be opened online or through a designated representative.

How to Invest in ETF?

For effective ETF investing, strategies like rupee-cost averaging are valuable. This involves regularly investing a fixed sum in an ETF, regardless of its price, helping to lessen the effects of market volatility and potentially reducing the average cost per share over time. Periodic rebalancing of your ETF portfolio is also crucial to maintain your desired asset distribution.

Realigning your holdings (selling high-performing and buying low-performing ETFs) can align your investments with your long-term objectives. Finally, understanding your risk appetite is key in ETF investment. Different ETFs come with varied risk levels, and it's important to match your investments with your comfort level towards market swings.

Conclusion

We have explored the ETF meaning and types, including equity, bond, and commodity ETFs, each with unique benefits and considerations. Understanding the key factors influencing ETF performance, such as expense ratios, tracking error, and liquidity, is crucial for making informed investment decisions.

Frequently Asked Questions

Q: Which is the best ETF in India?

A: The "best" ETF can vary based on individual investment goals, risk tolerance, and market conditions. Some popular options in India include Nifty 50 ETFs and sector-specific ETFs. Always research and consider your financial situation before investing.

Q: What are the top 3 ETFs?

A: The top 3 ETFs can change depending on the criteria used for ranking, such as returns, assets under management, or sector. Globally recognised ETFs often include SPDR S&P 500 ETF, Vanguard Total Stock Market ETF, and Invesco QQQ Trust.

Q: Is investing in ETFs good?

A: ETFs can be a good investment option as they offer diversification, lower costs compared to mutual funds, and flexibility of trading like a stock. However, like any investment, they come with risks and should fit your overall investment strategy.

Q: Is ETF good for beginners?

A: ETFs can be a good choice for beginners due to their simplicity, lower costs, and ease of trading. They provide an easy way to gain exposure to diverse assets, but beginners should still do their homework and understand what they're investing in.

Latest Comments

Related Information

Disclaimer: This Article is for information purpose only. The views expressed in this Article do not necessarily constitute the views of Kotak Mahindra Bank Ltd. (“Bank”) or its employees. Bank make no warranty of any kind with respect to the completeness or accuracy of the material and articles contained in this Newsletter. The information contained in this Article is sourced from empaneled external experts for the benefit of the customers and it does not constitute legal advice from Kotak. Kotak, its directors, employees and the contributors shall not be responsible or liable for any damage or loss resulting from or arising due to reliance on or use of any information contained herein.

Exchange Traded Funds (ETF) - Meaning, Types, Benefits