Definition of ETF

Description: ETFs were started in 2001 in India. They comprise a portfolio of equity, bonds and trade close to its net asset value. These funds mainly track an index, a commodity, or a pool of assets.

There are more than 50 ETF's trading in the NSE

To draw the distinction, let's consider mutual funds, index funds and ETFs separately.

1. What is a mutual fund

Once upon a time, only sophisticated investors had enough capital to justify hiring professional help. Now, a much larger number of investors of much more modest incomes seek a return.

Mutual funds rely on a professional adviser to actively manage investments on behalf of others, at a fee. The hope is that active management can take advantages of trends in the market or informational discrepancies to "beat" the overall market return.

2. What is an index fund

In 1976 the first index fund was launched by the investment firm Vanguard Group. It was known as "Bogle's Folly," for John C. Bogle, the founder of Vanguard. He believed that it was far more important to stay invested than to trade in and out. So, Bogle created a fund that tracked the S&P 500. It was the Vanguard 500 (VFINX). It promised to keep up with the broad index of stocks at a rock-bottom cost, and it still does.

It was considered folly because Wall Street at the time (and even today) was  invested in the idea of beating the market. Yet Bogle knew that most active managers can't do it, and even less so after subtracting their fees. Today there are hundreds of index funds, each tracking their own benchmark and typically at tiny fraction of active management fees.

3. What is an ETF?

You can think of an ETF as a form of index fund, in the sense that is has the same goal: To provide investors with a benchmark return at minimal cost. There is one important difference, however. Index funds are costly to trade, while ETFs often trade commission-free.

Not all ETFs are designed to mimic index funds, so be careful. Some have become little more than trading tools. If you want to have the flexibility of an ETF's low trading cost and performance similar to an index fund, it's best to use only the largest, most widely traded ETFs on the market, the ones designed to match well-known benchmarks and which have track records demonstrating their accuracy.

Types

Index ETFs

Most ETFs are index funds that attempt to replicate the performance of a specific index. Indexes may be based on stocks, bonds, commodities, or currencies. An index fund seeks to track the performance of an index by holding in its portfolio either the contents of the index or a representative sample of the securities in the index. As of December 2016, in India, about 20 index ETFs exist. Some index ETFs, known as leveraged ETFs or inverse ETFs, use investments in derivatives to seek a return that corresponds to a multiple of, or the inverse (opposite) of, the daily performance of the index.

Some index ETFs invest 100% of their assets proportionately in the securities underlying an index, a manner of investing called replication. Other index ETFs use representative sampling, investing 80% to 95% of their assets in the securities of an underlying index and investing the remaining 5% to 20% of their assets in other holdings, such as futures, option and swap contracts, and securities not in the underlying index, that the fund's adviser believes will help the ETF to achieve its investment objective. There are various ways the ETF can be weighted, such as equal weighting or revenue weighting. For index ETFs that invest in indices with thousands of underlying securities, some index ETFs employ "aggressive sampling" and invest in only a tiny percentage of the underlying securities

Stock ETFs

The first and most popular ETFs track stocks. Many funds track national indexes; for example, , and several funds track the S&P 500, both indexes for US stocks. Other funds own stocks from many countries; for example, iShares MSCI India ETF.

Stock ETFs can have different styles, such as large-cap, small-cap, growth, value, et cetera. For example, the iShares MSCI India Small-Cap ETF contain only small-cap stocks. Others such as ICICI Prudential Midcap Select iWIN ETF are mainly for mid-cap stocks. There are many style ETFs. ETFs focusing on dividends have been popular, For example R*Shares Dividend Opportunities ETF.

ETFs can also be sector funds. These can be broad sectors, like finance and technology, or specific niche areas, like green power. They can also be for one country or global. Critics have said that no one needs a sector fund. This point is not really specific to ETFs; the issues are the same as with mutual funds. The funds are popular since people can put their money into the latest fashionable trend, rather than investing in boring areas with no "cachet". For example, R*Shares Bank BeES is for banking sector.

Bond ETFs

Exchange-traded funds that invest in bonds are known as bond ETFs. They thrive during economic recessions because investors pull their money out of the stock market and into bonds (for example, government treasury bonds or those issued by companies regarded as financially stable). Because of this cause and effect relationship, the performance of bond ETFs may be indicative of broader economic conditions. There are several advantages to bond ETFs such as the reasonable trading commissions, but this benefit can be negatively offset by fees if bought and sold through a third party. For example R*Shares Liquid BeES

Commodity ETFs

Commodity ETFs (CETFs or ETCs) invest in commodities, such as precious metals, agricultural products, or hydrocarbons. Among the first commodity ETFs were gold exchange-traded funds, which have been offered in a number of countries. The idea of a Gold ETF was first officially conceptualised by Benchmark Asset Management Company Private Ltd in India when they filed a proposal with the SEBI in May 2002. The first gold exchange-traded fund was Gold Bullion Securities launched on the ASX in 2003, and the first silver exchange-traded fund was iShares Silver Trust launched on the NYSE in 2006.

Commodity ETFs trade just like shares, are simple and efficient and provide exposure to an ever-increasing range of commodities and commodity indices, including energy, metals, softs and agriculture. However, it is important for an investor to realize that there are often other factors that affect the price of a commodity ETF that might not be immediately apparent. For example, buyers of an oil ETF such as USO might think that as long as oil goes up, they will profit roughly linearly. What isn't clear to the novice investor is the method by which these funds gain exposure to their underlying commodities.

Trading

An important benefit of an ETF is the stock-like features offered. A mutual fund is bought or sold at the end of a day's trading, whereas ETFs can be traded whenever the market is open. Since ETFs trade on the market, investors can carry out the same types of trades that they can with a stock. For instance, investors can sell short, use a limit order, use a stop-loss order, buy on margin, and invest as much or as little money as they wish (there is no minimum investment requirement). Also, many ETFs have the capability for options (puts and calls) to be written against them. Covered call strategies allow investors and traders to potentially increase their returns on their ETF purchases by collecting premiums (the proceeds of a call sale or write) on calls written against them. Mutual funds do not offer those features.

They have the following advantages over mutual funds and equity/debt funds:

 1. Lower Costs: An investor who buys an ETF doesn't have to pay an advisory/management fee to the fund manager and taxes are relatively lower in ETFs.

 2. Lower Holding Costs: As commodity ETFs are widely traded in, there isn't any physical delivery of commodity. The investor is just provided with an ETF certificate, similar to a stock certificate.

List of ETF's trading in NSE in India