Exchange-traded funds (ETFs) have surpassed mutual funds as the most popular vehicle for passive investment in India. The reason is, that exchange-traded funds (ETFs) in India have lower costs than mutual funds. Unlike mutual funds, which typically have an expense ratio between 1.05% and 2.25%, ETFs often have a far lower cost ratio of less than 1%. Flexibility is another benefit of Exchange-traded funds. You may diversify your portfolio by purchasing many stocks instead of a small number of equities at random. When the market is open, you can buy and sell ETFs at any moment depending on the current market price.
Exchange-Traded Funds (ETFs): What Are They?
An exchange-traded fund (ETF) can be thought of as a collection of securities that together mirror the performance of one or more underlying assets. Like mutual funds, but listed on stock exchanges and traded on the open market instead. An index fund is one that tracks the performance of a certain index regardless of the direction of the market as a whole.
In the same way that a diversified portfolio includes stocks, commodities, bonds, and other investment options, an ETF does the same thing by combining these and other asset classes. Popular exchange-traded funds (ETF) tracking the S&P 500 index is the SPDR S&P 500 ETF (SPY). The prices of ETFs are very liquid, and they tend to follow market movements. This makes it possible for traders to purchase and sell shares at any time.
In 2001, ETFs were made available to Indian investors. Benchmark Mutual Funds introduced the world’s first exchange-traded fund (ETF) called NIFTY BEES (Nifty Benchmark Exchange Traded Scheme), which tracks the NIFTY 50 index.
ETFs can be broadly classified into the below 5 types:
Bond ETFs:
Traders may choose from a wide variety of Bond ETFs, including those that invest in both domestic and foreign government bonds as well as corporate bonds. The majority of bonds are kept until they mature because of their low liquidity. Bond exchange-traded funds, however, are actively traded in marketplaces. In other words, they are ideal for those who wish to enter the bond market but lack the necessary funds. Depending on the investor’s needs, bond ETFs can cover a wide range of bond types. Unlike broad-market ETFs, which focus on the market as a whole, specialized bond ETFs focus on a particular market segment, such as corporate debt, government bonds, etc.
Commodity ETFs:
Commodity exchange traded funds (ETFs) that focus on sub-sectors of the Indian market are available there. Investors may gain exposure to commodities through commodity exchange traded funds (ETFs) without having to study up on how to acquire futures or other kinds of derivative products. These exchange-traded funds (ETFs) invest primarily in futures contracts or own physical inventories of a single commodity. Those wishing to spread their bets over a wide range of asset types may find these ETFs particularly useful. However, to avoid traps, the investor must be knowledgeable of the future market.
Currency ETFs:
Currency exchange-traded funds (ETFs) in India function similarly to commodities ETFs. Investors can gain exposure to the underlying commodities market without taking actual possession of the asset by purchasing shares in exchange-traded funds (ETFs) that track the performance of the commodity. Currency exchange traded funds allow investors to capitalize on price fluctuations in foreign currencies relative to the US dollar. Shares of a currency ETF reflect a predetermined sum of a foreign currency. All investors looking to diversify their portfolios internationally should consider these ETFs. Currencies are getting more volatile, therefore it’s important to include currency investments as part of your overall investing plan.
Sector ETFs:
Sectors exchange traded funds (ETFs) are designed to help investors acquire equities inside a certain market segment. Sector ETFs allow investors to narrow their investment emphasis to a certain industry group rather than spreading their money out over a wide range of companies. If the industry you’ve picked is thriving, a sector ETF might be a wise investment. For instance, the pharmaceutical sector has provided profitable returns for investors during the Covid-19 epidemic. The risk is considerable since all of your money is invested in one place.
Gold ETFs:
Gold has always been a fantastic hedge against economic and monetary instability. Physical gold investing, however, has its own set of complications, including taxation, resale, quality, and resale. A gold ETF focuses on following the price of genuine physical gold and allows you to acquire an electronic representation of gold. It’s a synthetic exchange traded fund, much like the commodities ETF. One Gold ETF offers an investment in 1 gram of actual gold of the finest grade. The Gold Exchange Traded Fund (ETF) market is active on the Bombay Stock Exchange Ltd. (BSE) and the National Stock Exchange of India (NSE) (NSE).
ETF Comparison with Open-ended Mutual Funds & Close Ended Mutual Funds
- Open Ended Fund Closed Ended Fund Exchange Traded Fund
- Fund Size Flexible Fixed Flexible
- NAV Daily Daily Real-Time
- Liquidity Provider Fund Itself Stock Market Stock Market / Fund Itself
- Availability Fund Itself Through Exchange where listed Through Exchange where listed / Fund itself.
- Portfolio Disclosure Disclosed monthly Disclosed monthly Daily/Real-time
- Intra-Day Trading Not possible Expensive Possible at low cost
Why Invest in Exchange-Traded Funds (ETFs)
Adding an exchange-traded fund (ETF) is a fantastic way to spread your investment risk. There are a restricted amount of equities that you may buy when you invest in the stock market. Therefore, picking the right stocks is essential. As a consequence, if you are wondering how you may invest in ETF in India that follows a given sector or asset class, your portfolio will be more diversified and resilient. ETFs have a lot of advantages, including the following:
Similar to stocks, ETFs may be bought and sold on the stock market.
Since the ETF’s units trade at market values determined by investor sentiment, you have the potential to profit if the market is favorable to the sector or market that the ETF tracks.
When compared to mutual fund units, which can only be redeemed at specific times to take advantage of the current NAV, units can be bought and sold at any time during the day.
A typical exchange-traded fund’s expense ratio is lower than that of a mutual fund (especially actively managed mutual funds).
What to Consider Before Buying an Exchange-Traded Fund?
In India, investors can pick from a large range of exchange-traded funds. When seeking for subtleties on how you may invest in ETF in India, here are 4 crucial factors you should watch out for:
The Category of the ETF
Exchange-traded funds (ETFs) may be split into four distinct types: stock, gold, international, and debt. It’s not enough to just look at the overarching category; you have to go down into the granular ones, too. If you want to invest in stocks, for instance, an exchange-traded fund may focus on a certain industry or market cap.
The Trading Volume of the ETF
Exchange-traded funds (ETFs) were first made available in India in 2002. (ETFs). In the past, selling ETF units was not permitted at any time, but this restriction has been lifted. This is not always the case; certain ETFs do not have very high trading volumes compared to others. Getting a good return on your investment in an ETF requires picking one with high trading volume.
The Expense Ratio of the ETF
As was previously said, the expense ratio of an ETF is often lower than that of an actively managed fund. The expense ratios of several different funds have recently been lowered in an effort to attract new participants. When comparing two investments, the one with the lower expense ratio has the better chance of turning a profit.
Ensure Lower Tracking Error of the ETF
In most cases, ETFs will try to mimic the performance of an index. They try to replicate the performance of the index by investing in the same assets it uses. There will always be a disparity between the performance of an index and an exchange traded fund.
To measure how far an ETF has strayed from its index, the tracking error is calculated. Standard deviation of daily returns for the index and the ETFs is another metric to consider. The lesser the tracking error, the more closely an ETF’s returns mirror the index. Therefore, it is recommended to look for ETFs that have low tracking error.
Why ETF Failed in India?
Since most ETFs in India are passive products that aim to replicate the performance of an index, this shouldn’t be the deciding factor. After two or three years of market volatility, several exchange-traded funds (ETFs) like Gold have provided more stable returns. However, the most obvious explanation is…
When compared to the performance of diversified equities mutual funds over longer time periods, the performance of equity ETFs appears to be significantly worse. You should look into the DSP BlackRock Equal Nifty 50 Fund
The biggest advantage an investor looks for in an ETF is fewer fees, yet Indian funds score poorly even on this metric. Even while the average price for an exchange-traded fund (ETF) worldwide is just about.53%, most equity-related ETFs in India charge far more than this, with some even costing over 1%. One of the most prominent ETF providers, Vanguard, charges as little as.16%, and in other cases,.07%. This is feasible because of economies of scale, but the gap is still sizable.
Brokerage and other expenses linked to the management of an investor’s stock account are additional costs above and above the basic fees. However, keeping a demat account with a broker might be a hassle for investors who just want to put money into mutual funds.
Indexes are skewed when the top three stocks account for a disproportionately large percentage of the total. In the Sensex, the top three firms—Reliance, Infosys, and ICICI—account for 27% of the index. Worse still, the top two stocks in the bankex index account for more than half of the index’s weight.
Concerning liquidity, most Indian ETFs have subpar liquidity. You can’t always find something to purchase, and if you try to sell, you could find no takers.
Differences Between ETFs in India and the United States
There have been exchange-traded funds (ETFs) in the United States for 20 years, and this market sector continues to expand at a rate of 32% annually, with the reduced costs, the capacity of fund managers to outperform the larger index, and the diversity of ETFs all playing significant roles. When compared to other ETFs, India’s offering falls short in every category. Over twice as much money as the whole Indian mutual fund industry is invested in the largest ETF in the United States. Also, the overall value of all ETFs in the United States is $1 trillion, which is equivalent to almost two-thirds of the whole value of the Indian stock market. The number of exchange-traded funds (ETFs) listed in the United States is well over two thousand, but in India there are less than thirty (and another thirteen are pending permission from SEBI). The contrast is striking, but it remains true when discussing Indian Mutual Funds, where less than 1% of families have ever put a dime in the sector, but 39% of US households invest more than 50% of their financial assets through Mutual Funds. The lack of understanding of financial matters, insufficient infrastructure, excessive overhead, and low-quality labor force are all to blame.
In what way does India tax exchange-traded funds?
Now that we understand the nature of both types of earnings, we can examine the ETF’s taxation in India.
Taxation of dividends:
Exchange-traded fund distributions are subject to taxation at the individual taxpayer’s rate under the present tax system. For dividends in excess of Rs. 5,000, the firm or exchange-traded fund will withhold 10% in tax.
Capital gains taxation:
As was previously mentioned, the length of time an asset is held affects how long that gain is exempt from taxation.
Units in an equity-focused exchange-traded fund are liable to short-term capital gains if held for less than 12 months, and long-term capital gains if held for more than 12 months.
Units in gold and other exchange-traded funds are liable to short-term capital gains if held for less than 36 months, and long-term capital gains if held for more than 36 months.
Equity-focused exchange traded fund:
According to Section 111A of the Income Tax Act, the rate of taxation for capital gains realized in a short period of time is 15%.
In accordance with Section 112A of the Income Tax Act, taxpayers must pay 10% tax on long-term capital gains that are more than Rs 1 lakh. It’s important to remember that these increases will not be eligible for indexation.
Taxes on Gold ETFs and Other ETFs:
Gains on investments held for less than a year incur taxes at the highest rate for which the taxpayer is liable under the Income Tax Act.
According to Section 112 of the Income Tax Act, the tax rate on long-term capital gains is 20%. Remember that such increases will be eligible for indexation benefits.
Exchange-traded fund margins in the classic model (ETFs)
You can either actively or passively manage an ETF, or exchange-traded fund. The goal of a passively managed exchange-traded fund (ETF) is to provide results that are identical to those produced by a certain benchmark, such as the Standard & Poor’s 500 Index or the Dow Jones Industrial Average (DJIA). For investors seeking low-cost market-tracking returns, index exchange-traded funds (ETFs) are a viable option. These funds hold a diversified portfolio of stocks and trade like a stock exchange.
Under FINRA regulations, the margin requirements for traditional ETFs are the same as for stocks. A broker may extend a loan of up to half the purchase price of margined securities for first purchases. Following that date, the borrower’s equity cannot fall below 25% of the original loan amount.
How can you invest in an ETF?
You will need both a trading and a Demat account with a brokerage in order to buy and sell exchange-traded funds (ETFs). After you’ve done this, you’ll be ready to choose an ETF that helps you achieve your financial objectives. While selecting an ETF, it is important to take into account your desired level of exposure to overseas markets, investment horizon, and risk tolerance. Knowing this, you’ll be able to make educated ETF trades during market hours and see your money increase.
Concluding Remarks
Be well-versed in your options and formulate a plan to reach your financial goals while taking into account your level of risk tolerance and the amount of time you can commit to the process. Before putting money into an ETF, you should develop a plan for investing and familiarize yourself with its nuances.
Since they are passively managed, their goal is only to provide results that are identical to those of the index. Consequently, it is critical to maintain reasonable expectations. If you are a frequent investor or trader, you may also want to consider using ETFs in your portfolio for added security. Invest wisely after careful consideration.
FAQS
1.Ques: How to invest in ETFs in India?
Ans: During the trading sessions in India, you can purchase ETFs. Finding the exchange-traded fund (ETF) you wish to buy is as simple as logging into your Demat account. Exchange-traded funds (ETFs) exist for a wide range of markets and investment philosophies.
2.Ques: Is ETF a good investment in India?
Ans: Exchange-traded funds (ETFs) are useful for portfolio diversification. Investing in ETFs is safer than investing directly in stocks because of the greater diversity they offer. Since ETFs are traded on the markets, they are also more liquid than mutual funds.
3.Ques: Can I sell ETF anytime?
Ans: During trading hours, a trader can sell exchange-traded funds. ETFs offer greater liquidity than mutual funds, which may only be sold to the fund management during non-market hours.