Investment tips for Exchange Traded Funds​​​

Exchange Traded Funds - A resourceful product to invest in asset classes 

 

Mutual Funds provide an important and convenient way of financial planning for retail investors due to various factors such as economies of scale and low costs. In addition, Mutual Funds also provide investors with an opportunity to invest across asset classes, sectors and geographies via various schemes. Further, investors can diversify their portfolios by following different investment styles of wealth or fund management, viz., the active style or the passive style. Those funds which

consistently churn their portfolio and aim to outperform the market or a benchmark index are called actively managed funds. In contrast, those funds which aim to generate returns in line with a benchmark index by replicating its portfolio are referred to as passively managed funds.

    

Exchange Traded Funds (ETFs)

Passively managed funds are best represented through ETFs. These funds invest into an underlying asset or portfolio of assets and trade over stock exchanges. The underlying portfolio may represent an index, securities or commodities. ETFs can be easily bought / sold anytime during market hours like any other stock on the exchange. The trading price is usually close to the fund’s actual net asset value (NAV). Investments in ETFs, however, require investors to hold share trading and demat accounts. 

    

Investing in ETFs

ETFs can be bought or sold in two ways. But before you begin to invest in ETFs, it is important that you take into account the following points: 

1. You need to open a trading account with a broker/ sub-broker.

2. You should also have a demat account for holding the ETF units.

  

To complete these formalities, you have to be KYC compliant and required to furnish documents like:

A. Proof of identity: Passport, Driving License, PAN Card

B. Proof of Address: Passport, Utility Bill

C. Bank Account Details: Bank Account Statement

After you complete these formalities, you can buy and sell ETFs through this account.

    

You can invest in ETFs by:

A. Buying or selling ETF units through the broker by telephonic mode or by placing orders on the online trading terminal provided by the broker. You should also check whether the broker is registered with the stock exchange. 

B. You can place your order by calling your broker and informing him about your trade specifications. 

C. You can also place your order through online trading terminal. Trading ETFs is similar to buying and selling shares on exchanges through the terminal. Benefits of investing in ETFs:

  

Diversification: ETFs offer you exposure to a wide range of securities like an index and are traded like a stock. ETFs help you spread investment risk over a number of securities and reduce stock-specific risk. Investment in ETFs can be looked at as a part of hedging strategy. Depending upon the ETF scheme, you can gain exposure to a range of stocks, countries. Sectors, commodities etc in a single transaction.

  

Transparency: Most of the ETFs track an index and this would mean passive management for the fund house to maintain the ETF portfolio. This makes it easier for the investor to know performance of the ETF.

  

Portfolio Management: ETFs help fund managers with constant inflow and out flow of funds. ETFs are liquid investment products that fund managers can easily buy or sell on exchange. This help in effective portfolio management for the fund managers. 

Convenience: You can buy and sell ETF shares on exchanges by looking at the market prices available on the trading portal. ETFs are listed on exchanges that are well regulated. This has contributed to transparency in trading ETFs. Also, investors who are unsure of which investment product to choose can invest in Index ETFs, which will provide them exposure to the market.

  

Lower Transaction Charges: ETFs can be traded at much lower cost that what you would incur on other index tracking products. Investors who are unsure of which stock to invest in can invest in a sector-based ETF and benefit from the sectoral growth by investing a small amount of capital.

  

Tax Benefits: Dividends from ETF schemes are tax exempt for investors. If an investor sells ETFs units before 12 months, he is liable to pay short term capital gain tax at the rate of 10 percent. At the time of redemption the investor need not pay tax. They are also exempt from wealth tax. However, the time of redemption investors would need to pay securities transaction tax (STT) at 0.25 percent on the value of redemption.

  

Arbitrage Opportunities: ETFs, being index tracking products, can be used to generate profits out of price differences between ETFs and other index products like futures etc. 

  

Conclusion 

Though Indian ETFs are still at an emerging stage, they are expected to replicate some of the asset classes that are offered globally, with gold ETFs the likely leader. Recent launches, which include differentiated products such as MOSt Shares NASDAQ 100, Goldman Sachs Hang Seng BeES, Goldman Sachs S&P Shariah BeES, give investors diverse but attractive choices across asset classes, investment styles and geographies. While actively managed funds will continue to rule in search of higher alpha, passively managed funds in the form of ETFs can be of able help to investors for quick diversification across underlying asset class / index.