All about exchange traded funds (ETF)

Mutual Funds | admin | November 14, 2010 at 10:05 pm

Q: What would you set out as a basic definition of ETFs? What is it about?

Shah: The ETF basically is a fund which you can buy everyday in the market. In simple term, it’s a mutual fund which basically you have to buy, and you can easily buy in the stock exchange.

Q: You agree with that? Is that a fair and simple explanation of the product?

Laxmi: Yes absolutely. An ETF is nothing but a very passive form of investing into the underlying index or the constitution or the asset class and it broadly mimics the underlying index or what the underlying is. You can freely transact it on the exchange by the virtue of it being listed on the stock exchange. So in effect what you are getting is the convenience of transacting in a stock kind of a form in a mutual fund unit.

Q: If you had to set out the key three-four differences between a mutual fund and an ETF, what would you say are the primary differentiators?

Shah: The basic differentiator is that ETFs are usually on a passive fund. So what happens is typically the fund manager is not talking any active calls on the portfolio at all. You just go and buy the underlying asset be it an index, say a Nifty or a junior Nifty, or a bank or you just go and buy gold. In terms of the other funds typically, the fund manager is taking active calls as to what makes sense for him in the market.

The second difference would be that you can buy at real time prices. The biggest advantage of an ETF is that if the markets are down today say at 2% or 3% in a normal fund if you buy the fund on the same day you would get the end of the day NAV. So if the markets moved say since 10:00am in the morning to 3:00pm by 2-3% you would miss out on that movement and you will actually pay 2-3% higher or if you sell you lose out 2-3%.

Thirdly, the difference is all the units of the mutual fund go into a demat account. So it’s not a statement of account, so you can actually see those your units in your demat account and add upto your own portfolio. So these are the basic differences I would say from between an ETF and a normal open-ended fund.

Q: But there are also active ETFs versus passive ETFs. Is that not available in India, what is the difference there?

Shah: Active ETF is a very new concept. It’s just taking shape in the US market. The size is not really grown too much. We don’t have it in India at all at this point in time. What we have in terms of differentiation of a passive ETF is the whole idea of fundamentally weighted index and you weight the stocks in a very different manner and you create your own index and then invest in them.

It is a little different from the public indices which you have like S&P 500 or Nasdaq or Nifty—these are indices which everybody owns and themselves do it but again its investing in an index be it that you are investing in an index which is your own index. Active ETFs have just about started taking off in the US. We don’t have a lot of size in that—the total size as I understand is as about USD 2-3 billion and in India you don’t have it in this point in time at all.