What are ETFs? The ETF advantage

What are ETFs?

ETFs are mutual fund schemes and, like stocks, they are listed and traded on the stock exchanges. The prices of such funds are valued continuously and can be purchased/ sold throughout the trading day. This flexibility in buying and selling allows investors to take advantage of the intra-day price movements.

In comparison, those investing in a traditional mutual fund can purchase units only at the fund’s NAV, which is published at the end of each trading day. The trading and settlement mechanism of ETFs is similar to that of a regular equity share. Their trading prices are very close to their NAVs, unlike the substantial premiums/ discounts associated with closed-ended funds that also trade on the exchanges.

In India, ETFs are currently available in equities, money market instruments (known as liquid ETFs) and gold. Equity ETF is a basket of stocks, which reflects the composition of an index, say, the S&P CNX Nifty or the BSE Sensex. The ETF’s trading value is based on the net asset value of the underlying stocks that it represents. It is priced at one-tenth the respective index value. So, if the index is trading at 5,400, its ETF will be priced at Rs 540.

On the other hand, liquid ETFs invest in money market securities like treasury bills or treasury papers issued by the government, and the like. Their investment objective is to deliver money market returns with lower risk and more liquidity. Gold ETFs are special units representing physical gold, either on paper or in a dematerialised form.

The ETF advantage

Liquidity and the ability to represent the market are the biggest attractions of ETFs. If you like a particular sector, say, banking, but are unsure about which stock(s) to buy, investing in shares tied to an index or a basket of stocks will give you diversified exposure and reduce stock-specific risk.

ETFs can also act as hedging tools; they can be sold short if the market outlook is negative. A hedge can be created by shorting them against long stock holdings. Since ETFs don’t require any hands-on management to tackle risk while increasing returns, it makes them a winner for many an investor.