Convenience of Investing
Exchange Traded Funds are essentially Index Funds that are listed and traded on exchanges like stocks. They enable investors to gain broad exposure to entire stock markets in different Countries and specific sectors with relative ease, on a real-time basis and at a lower cost than many other forms of investing.
An ETF is a basket of stocks that reflects the composition of an Index, like Nifty or BSE Sensex. The ETFs trading value is based on the net asset value of the underlying stocks that it represents. Think of it as a Mutual Fund that you can buy and sell in real-time at a price that change throughout the day.
ETFs are modern day Mutual funds which have several advantages over traditional funds. The key advantages of investing in ETFs are the following:
Low cost: Both traditional funds and ETFs charge fund management charges and operating expenses to the Scheme. However, due to the very nature of ETFs, both the expenses are streamlined and much lower as compared to open ended mutual funds charges. ETFs protect the interest of the long term investor from the inflows and outflows of short-term investors.
Portfolio Diversification: ETFs provide exposure to the market through a basket of securities which results in portfolio diversification and better risk management. They provide wide variety of sector, style, industry and country specific funds thereby giving a wide choice of diversification to the investor.
Convenience of Investing: ETFs provides you the convenience of trading during market hours and makes it very convenient to buy and sell at any point of time between 9 am and 3.30 pm (current trading hours). Unlike traditional mutual funds, one need not wait till the closing of market hours to know the price at which the trade is executed. Thus, Investors invests in real-time prices as opposed to end of day prices. If you have brokerage account, all you have to do is either go online and place order or call your broker and place an order. It is as simple as buying any share/stock of a Company.. The procedure is same if you want to redeem your investments partially or fully.
Arbitrage Opportunities: Since ETFs are easy to buy and sell, it also helps an investor to manage his portfolio actively and reduce risk. For example if the investor’s exposure is high on banking stocks and he wants to have a hedge, he can technically short Banking sector ETF or other similar sector ETFs to actively create a portfolio using underlying ETFs.
Transparency: ETFs are as transparent as clear glass. The indicative NAVs are available real time to an investor and so is the basket of securities that consists the portfolio. This will help investor to understand what he is investing into and at what price, thereby making the investment decision an informed one.
Market risk: Like any other market related investment product, ETFs also carry the market risk. Though you cannot mitigate the risk you can always reduce it by investing across markets and sectors.
Trading cost: There is a trading cost to be incurred every time you buy or sell ETFs. The rates will depend on the overall volume that you do across securities with your brokerage firm.
BID – ASK price spread: There is a spread between the bid price (highest price a buyer is willing to pay for a share) and ask price (lowest price a seller is willing to accept for a unit). The amount of spread varies from one ETF to another. The same is neutralized by higher liquidity.
Tracking Error: Index ETFs tracks the underlying index. The returns generated by ETFs can marginally be more or less than the index it tracks. This is due to the fact that the ETFs will maintain some cash in the portfolio unlike the index.
1. Asset Allocation: Asset allocation managing could be difficult for individual investors given the costs and assets required to achieve proper levels of diversification. ETFs provide investors with exposure to broad segments of the equity markets. They cover a range of style and size spectrums, enabling investors to build customized investment portfolios consistent with their financial needs, risk tolerance, and investment horizon. Both institutional and individual investors use ETFs to conveniently, efficiently, and cost effectively allocate their assets.
2. Cash Equitisation: Investors typically seek exposure to equity markets, but often need time to make investment decisions. ETFs provide”Parking Place" for cash that is designated for equity investment. Because ETFs are liquid, investors can participate in the market while deciding where to invest the funds for the longer-term, thus avoiding potential opportunity costs. Historically, investors have relied heavily on derivatives to achieve temporary exposure. However, derivatives are not always a practical solution. The large denomination of most derivative contracts can preclude investors, both Institutional and Individual, from using them to gain market exposure. In this case and in those where derivative use may be restricted, ETFs are a practical alternative.
3.Hedging Risks: ETFs are an excellent hedging vehicle because they can be borrowed and sold short. The smaller denominations in which ETFs trade relative to most derivative contracts provides a more accurate risk exposure match, particularly for small investment portfolios.
4.Arbitrage (Cash Vs Futures) and Covered Option Strategies: ETFs can be used to arbitrage between Cash and Futures Market, as it is very easy to trade. ETFs can also be used for cover Option strategies on the Index.