Exchange Traded Funds (ETFs) are pooled investment funds that are traded on stock exchanges and aim to track the performance of an underlying index or asset. Based on where ETFs invest, they can be grouped into equity, debt, commodity, and international ETFs in India.
You are probably familiar with the full form of ETF as Exchange-Traded Funds. But do you know what these funds actually are, how they work, and what are their types?
If, like most beginners, you lack clarity on what is an ETF, read this guide to learn all about ETFs and the most common types available in India.
Table of Content
What is an ETF?
An ETF (exchange-traded fund) is a type of fund that invests in a basket of securities, such as stocks, bonds, gold, or other assets. Unlike regular mutual fund units, ETF units are listed on stock exchanges and can be bought and sold during market hours.
What is an ETF becomes clearer when you understand its core characteristics:
- Tracking an underlying index or asset: ETFs aim to track and replicate the performance of an underlying index, asset, or sector.
- Demat and trading accounts needed: The Demat account holds the ETF units in an electronic form, while the trading account facilitates buying and selling of units.
- Passively managed investments: Most ETFs are passively managed as they simply track an underlying asset/index. No active stock section means lower management costs for investors as compared to actively managed funds.
- Diversification: By buying a single ETF, you can gain exposure to an entire portfolio of assets, which may spread overall portfolio risks to an extent and may offer diversification benefits.
How Do ETFs Work?
Knowing the full form of ETFs and their key characteristics isn’t enough. You also need to understand how they work. ETFs work by tracking the performance of an underlying index or asset.
Let’s say we take the example of an index ETF. Here’s how it generally works:
- The ETF tracks a chosen index: The fund house selects a suitable benchmark index, such as the Nifty 50. The ETF then invests in securities that make up the index, generally in similar weightage and proportions, intending to track its performance.
- ETF units are listed on the stock exchange: Investors can buy and sell these units during market hours through a Demat and trading account, much like shares.
- The ETF price changes during the day: Since ETF units trade on the exchange, their market price moves during trading hours based on demand and supply. It may also differ from the fund’s NAV, which reflects the value of the underlying portfolio.
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Types of ETFs in India
ETFs can be classified into different types based on where they invest. The most common types of ETFs in India are listed below:
1. Equity ETF
Equity ETFs invest in shares of listed companies based on a defined investment strategy. Most equity ETFs aim to track a particular index, which represent the broader market, a specific sector or theme, or a group of stocks selected using certain factors.
Equity ETFs can be broadly classified as follows:
| Type of Equity ETF | What It Means |
| Index ETFs | These ETFs track a particular market index like the Nifty 50 or Sensex to offer potential returns in line with the index performance, subject to tracking error. According to SEBI, index ETFs invests at least 95% into the index securities. |
| Sectoral ETFs | These types of ETFs track indices that focus on a specific sector, like banking, auto, or IT. That’s why the performance of these ETFs is closely linked to the sector’s performance, subject to tracking error. |
| Thematic ETFs | These ETFs invest based on a given theme, such as consumption, infrastructure, or manufacturing. This theme can spread across different sectors. |
| Factor-Based ETFs | These ETFs track indices that select or weigh stocks using defined factors such as value, quality, momentum, or low volatility. |
2. Debt ETF
Debt ETFs invest in a basket of fixed-income securities and are traded on stock exchanges like other ETFs. Depending on the ETF, the portfolio may include government securities, corporate bonds, treasury bills, or other debt instruments.
Some common types of debt ETFs include:
| Type of Debt ETF | What It Invests In |
| Government Bond or Gilt ETFs | Track indices made up of Central Government securities across different maturities. They carry low credit risk but can be affected by interest-rate changes. |
| Corporate Bond ETFs | Invest in corporate bonds based on the ETF’s underlying index. Some may focus on highly rated bonds. They carry credit risk linked to the issuers. |
| PSU Bond ETFs | Invest in bonds issued by public sector undertakings and other eligible public sector entities, depending on the index tracked. |
| State Development Loan ETFs | Invest in State Development Loans issued by state governments. Their prices can still move with changes in interest rates. |
| Target Maturity ETFs | Track a debt index with a defined maturity date and invest in bonds that mature around that period. The ETF winds up at maturity and distributes the proceeds to investors, subject to the scheme terms. |
3. Commodity ETF
Commodity ETFs provide investors exposure to commodities without needing them to physically buy, store, or manage the commodity. In India, there are two main types of commodity ETFs:
| Type of ETF | Where It Invests | What It Tracks* |
| Gold ETF | Invests at least 95% into physical gold of 99.5% purity, subject to applicable SEBI norms. | Tracks the domestic price of gold. |
| Silver ETF | Invests at least 95% in physical silver of 99.9% purity and silver ETCDs (subject to SEBI limits). | Tracks the domestic price of silver. |
*Disclaimer: Commodity ETF schemes aim to track commodity prices subject to tracking errors.
4. International ETF
International ETFs give investors exposure to securities listed in markets outside India. Depending on the ETF, they may track a foreign market index, a particular region, or a specific overseas sector or theme.
For example, an international ETF may provide exposure to:
- Overseas broad indices such as the S&P 500 or Nasdaq 100.
- Specific countries or regions like the US, Japan, or other international markets.
- Global sectors or themes like international technology or other sector-focused indices.
Investing in international ETFs may help investors add geographical diversification to their portfolios. However, you should note that performance can be impacted by currency movements, overseas market conditions, etc.
Conclusion
Now you know that the full form of ETFs is exchange-traded funds, and these funds invest in a basket of securities. They aim to track the performance of an underlying index, sector, or asset and provide returns in line with the same, subject to tracking errors.
As an investor, you can choose to invest in equity, debt, commodity, and international ETFs in India. You can buy and sell them at any time during the trading hours. But please remember that picking a suitable ETF depends on your investment objectives, risk appetite, and existing portfolio’s composition.
FAQs
What is an ETF fund?
The full form of ETF is Exchange-Traded Funds. It is a type of fund that holds a basket of securities or assets and trades on a stock exchange. Depending on its objective, an ETF may track an index, bonds, gold, silver, or international markets.
How to invest in ETFs in India?
You can invest in ETFs through recognised stock exchanges like the NSE or BSE. ETFs are listed on these exchanges under their ticker symbol. However, please remember that you need to have a Demat and trading account to invest in ETFs in India.
Do ETFs pay dividends?
Some ETFs may pay dividends if the stocks they hold pay dividends.
What are the benefits of investing in an ETF?
There are several potential benefits of investing in an ETF:
- Diversification: Exposure to a basket of securities or assets through one investment.
- Lower costs: Passively managed ETFs may generally have lower management costs.
- Easy trading: ETF units can be bought and sold on stock exchanges during market hours.
- Transparency: Investors can regularly check the securities or assets held by the ETF.
- Wide exposure: ETFs can provide exposure to equities, debt, gold, silver, and international markets.
Are ETFs safe to invest in?
ETFs are market-linked investments, so they are not completely risk-free. The level of risk involved in an ETF depends on what it invests in. For example, an equity ETF, gold ETF, and debt ETF can have very different risk profiles. Investors should check the underlying assets, index, liquidity, tracking error, and scheme riskometer before investing.
Disclaimer
- An Investor Education and Awareness Initiative by Tata Mutual Fund.
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- This communication is a part of investor education and awareness initiative of Tata Mutual Fund.
*Mutual Fund Investments are subject to market risks, please read all scheme related documents carefully.
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