Sharekhan Blog

Exchange Traded Funds (ETF)

  • Mar 4, 2024

Thereby, ETFs allow affordable exposure, benefiting from professional management and avoiding legwork.

The ETF full form Exchange-traded funds (ETFs) have emerged as a popular choice due to their unique characteristics that blend the features of mutual funds and stocks. This article covers what is and the full form of ETFs, focusing on how ETF works, ETF mutual fund distinctions, and how to invest in ETFs in India.

What is ETF Funds?

ETF funds or exchange-traded fund constitutes a financial security mirroring selected market indices, like the Nifty 50 or sector subsets encompassing underlying investor capital funding professional management around defined mandates capping deviations through passive tracking, unlike active funds attempting to beat averages. Thereby, ETFs trade throughout market hours, enabling intraday entries or exits.

How ETFs Work?

ETF issuers determine target market segments by aligning proposed product offerings. After gauging investor demand success probabilities, they launch differentiated ETFs pooling capital from unit-buying investors to fund-building diversified portfolios representatively mirroring stated benchmarks through optimising selection and weighting decisions. 

In essence, ETFs or exchange-traded funds trade like stocks, harnessing combined investor assets. This allows affordable fractional participation in equity markets through passively managed trust structures focused on maximising index alignments rather than attempting excess alpha generation through active stock picking or market timing. Thereby, etf funds simplify investments in a diversified basket of securities across various sectors, market caps, industries, etc.

Types of ETFs

  • Equity ETFs: Offer diversified equity participation through fractional ownership in a portfolio representationally mirroring underlying indices like Nifty 50.
  • Fixed Income ETFs: Allow bonds asset exposure tracking aggregative debt indices.
  • Sector/Thematic ETFs: Permit-focused equity participation in sectors like IT, Pharma, or Banking exclusively.
  • Commodities ETFs: Offer diversified commodities exposure across precious metals, agriculture, and energy verticals.
  • Leveraged ETFs: Employ financial derivatives augmenting directional exposures beyond 1:1 ratios for amplified returns potential.
  • Actively Managed ETFs: Unlike passive index-hugging ETFs, fund manager stock selection aims to beat averages.
  • Inverse ETFs: Allows magnified short exposures benefiting from a downward trajectory in the parent index.

Thereby, abundant ETF varieties cater to specific strategy needs, suiting risk appetites when aligned judiciously to financial planning.

Benefits of Investing in ETFs

While mutual funds settle only once daily, ETF funds afford flexible liquidity through seamless intraday trading, enabling timely entries or exits that suit market views or events. Thereby, strategies pivot nimbly, harnessing evolving dynamics through active position management rather than depending on inertia. This proves vital in capturing short-term inflexions.

Additionally, ETFs minimise fee leakage, maximising investor upside capture through lower expense ratios stemming from passive management, unlike typical actively managed mutual funds charging higher pound flesh, continually eroding long-term wealth creation. Thereby, savings compounds benefit loyal investors significantly more over extended horizons, consistently generating alpha relatively.

Risks of ETFs

However, ETF trading does attract proportionate brokerage, demat, and STT costs applicable per transaction, which proves marginally costlier if investing tiny sums frequently over time rather than holding lump sum purchases patiently. Therefore, choice depends on periodic investment magnitude suitability.

Meanwhile, lightly traded niche ETFs suffer from wide spreads between demand and supply pricing, hampering cost-effective, efficient entries or exits due to underlying liquidity mismatches preventing orderly trading. Thereby, niche avoidance proves prudent until milestones are breached, ensuring requisite volumes safeguarding integrity.

How to Invest in ETF?

Investing in ETFs requires following a few key steps:

Step 1: Open a Brokerage Account

The first step is to open an account with a brokerage firm that allows the buying and selling of ETFs. Choosing an SEC-registered brokerage firm is advisable. Paperwork involves providing personal details and verification information.

Step 2: Choose the ETF

Next, investors have to select the appropriate ETF aligned with their investment goals and risk tolerance. Assess the underlying asset class and index-tracked past performance and liquidity before selecting an ETF. Focus on long-term metrics over short-term volatility.

Step 3: Transfer Funds

Once the brokerage account is opened, transfer the investment amount to the trading account through online banking channels, wire transfer, or account funding options provided.

Investing in ETFs entails following these main steps along with staying updated on performance and rebalancing holdings periodically. Executing these steps can help gain effective exposure to diverse assets through ETF instruments.

Conclusion

Exchange Traded Funds constitute an accessible financial instrument enabling fractional participation in diversified portfolios of assets like stocks, bonds, or commodities through pooled structures that passively track designated indices. Their blended nature harnessing positive mutual fund and equity attributes makes ETFs a convenient avenue for affordable index-linked market exposure.

By following key steps like opening a trading account, judiciously selecting well-researched offerings, aligning strategy to goals, and transferring investment capital, investors can conveniently incorporate ETFs in their portfolios. Their passive indexing focus, transparency, flexible liquidity, and lower costs confer definitive advantages for building long-term wealth aligned to risk tolerances.

Team Sharekhan
by Team Sharekhan

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