Okay but laana:
Tell me more about these ETFs
17th July 2021
Reading time ~ 3 minutes
Hi there,
Last week, we had done an explainer on index funds and what they mean for you. This time, we're going to do a small explainer on ETFs since this is something you'll come across pretty frequently when it comes to the index funds debate. As usual, we'll be breaking down the jargon and talk about what they mean for your journey.
Before you read up about ETFs, make sure you've read through the index funds explainer - which you can find here.
Cool, so what are ETFs?
Exchange Traded Funds
Mhmm, okay but what are Exchange Traded Funds?
Think of it this way - when you invest in index funds, you buy into a basket of stocks, like the Nifty 50. You basically go to the "mutual funds" section of apps like Groww/ Coin or you invest directly through the website of the fund itself, right?
Now, with an ETF (say a Nifty ETF) - you are still buying into the same basket of 50 stocks, but instead of going the mutual fund route, you are directly buying/ selling the basket from an exchange (like the NSE, BSE). Just like how a stock is listed and traded on an exchange, an ETF is also listed and traded (i.e. bought and sold) on the stock exchange itself - thus, the term "Exchange" Traded Funds. You do this buying/ selling through a broker - could be your neighborhood broker, or through a brokerage platform like Groww, Zerodha, etc.
There are several types of ETFs currently available that you can choose from - from Nifty ETFs, Sensex ETFs, Sectoral ETFs (banking, healthcare), to international market ETFs (and many more).
Cool, so now that we know what ETFs are, we'll talk about Nifty Index Funds vs Nifty ETFs. The principles of why one invests in these passive forms of investing remain the same - we discussed these last week. However, both differ in their overall structure and have their own pros and cons, which we'll discuss:
Both Nifty Index Funds and Nifty ETFs are similar in the sense that they track the Nifty 50 stocks and passively maintain the tracking. There's no fund manager taking a call on which stocks to buy and which to sell. Both will also have some tracking error that you'd want to minimize. They will also have associated costs, which you'd also want to minimize:
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Index funds have costs in the form of expense ratios (+ certain additional stamp duty)
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ETFs have costs associated with buying and selling on the stock exchange - brokerage charges (although you have platforms that don't charge brokerage); stock exchange charges, GST, stamp duty, etc. - you'd want to check the total costing with your broker. They also have admin charges - for Nifty ETFs, currently between 0.05% - 0.12%.
Index funds' expense ratios have been higher than ETF costs - however, with the introduction of very low-cost index funds, the gap is reducing and index funds are also becoming quite cost-efficient.
Next, we'll talk about how they differ:
First off, we know that ETFs are traded on the stock exchange - so just like how you need a Demat/ Trading account to buy and sell stocks directly, you need this setup for ETFs as well (not required for index funds).
Secondly, in order to buy into an index fund, you would just go to the website (or one of the apps), and place a request to buy the fund's scheme. You'd follow a similar procedure to redeem any amount as well. Your allocation/redemption of the units of the mutual funds is based on the asset value calculated by the fund at the end of the trading day (so, it's not real-time).
For ETFs, you'll have to go through a brokerage platform - place an order and then buy the ETF (essentially, there is a seller that is willing to sell on the other side). Similarly, when you want to sell the ETF, you do a similar process, and you're matched with a buyer that wants to buy the ETF at the agreed price. It's like how any marketplace works. There's no calculation of value happening at the end of the day - the transaction and pricing are real-time.
The issue here, however, is that with certain ETFs in India, it's not always easy to match with a buyer/ seller - either there are not enough folks on the other side, or the prices are not necessarily favorable, causing a "liquidity" issue with the ETF - so you are not able to sell the ETF quickly and get your cash back. You don't have to worry about this with an index fund.
Finally, with Index funds, you can invest a defined amount and set an SIP for every month. With ETFs, you have to invest in multiples of the price - so if the ETF is trading at 170, and you wanted to invest 2000 bucks, you won't be able to do that - you'll have to either invest INR 1870 (170*11) or 2040 (170*12). SIPs for ETFs are possible on certain brokerage platforms, but not all.
Andd that's pretty much it. All in all, it's about flexibility and convenience. ETFs offer flexibility of buying/ selling at any point in the day and usually cost a little less. Index funds offer convenience - you can buy into the fund easily, do an SIP, sit back and relax. If you already have a demat/ trading account and are on a brokerage platform - you can always explore ETFs. Make sure you research beforehand on how orders, volumes, liquidity, etc. work so you're aware before transacting.
You can find different ETFs, their expense ratios, and tracking error here.
Thoughts or questions? Reach out to me at rujgupta@laana.club
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