We have heard the term ETF or exchange traded fund. But do we all know what is ETF? We have an idea of how mutual funds work. They take money from the investors and invest the same in different stocks. After that, they open a net asset value and create per unit price and sell the investor number of units according to their investment. The investor can track his unit price every evening, whether it is moving up or down. ETF also works as mutual funds, the only difference is they are listed on the stock exchange.
A mutual fund company can make any of its fund with whatever number of shares in it, say 40 or 50 shares portfolio, as an exchange traded fund. That ETF gets listed in the stock exchange, that you can buy or sell like any ordinary share. Many companies have introduced their ETF, like Reliance Mutual Fund, Birla Sun Life Mutual Fund, SBI Mutual Fund etc. Most of the companies who have an asset management company or AMC, they have introduced their ETF and got them listed in the stock exchange.
So we understood what is ETF. ETF generally made out of things that are not present in the physical form. Suppose Reliance Industries stock is present in the semi-physical form. If you wish you can take or buy a stock of Reliance. But if you want to buy the Nifty index, you can not buy it because Nifty is an index made of 50 shares. Now if an investor wants to invest in Nifty directly he needs to trade its future or derivative. This is ok for a trader, but a long-term investor cannot buy it in cash and take the delivery. It is not possible for him to buy a future and roll over the contracts at every expiry.
Another way an investor can directly invest in Nifty is to invest in Nifty’s ETF or exchange traded fund. This ETF is listed on the exchange in the name of NIFTYBEES. It works right like a stock. You can buy or sell it, short sell it, trade it on margin, you can do everything that you can do with a stock. It has a same T+2 settlement.
If we buy a mutual fund, we get to know the NAV only in the evening. But the price of an ETF can be tracked in the market hours just like a normal stock. It is also not necessary for an ETF to trade exactly at the same price of the underlying. Like NIFTYBEES can have some price difference with Nifty index. Bank Nifty index also has an ETF or BEES named as BANKBEES. It also priced almost same to Bank Nifty index, but will never be exactly same because the BEES price will be dictated by demand and supply. So an investor can invest in an ETF or BEES and keep it as long as he wants by taking the delivery.
ETFs can be of different investment products. Like Nifty ETF, Bank Nifty ETF etc. There is an ETF called CPSE ETF. It is comprised of some government company’s stocks, all the Maharatan, Navaratan and Mini Ratan companies. It is also listed on the stock market. So by investing in the ETF, an investor can get a feeling in all those companies. Check the CPSE ETF advertisement, that gives you the idea of what is ETF.
The ETF will perform same as the underlying companies will perform. If the companies do not perform well, the price of the ETF will go down and if they perform well, the price of the fund will go up. So to understand what is ETF, we got to know it is same like an MF. Just like MFs here also a unit price is decided and the same is listed in the exchange and the unit price moves up or down based on the demand and supply. Nowadays, Nifty is priced around 10500, its ETF or BEES is priced around 1050. If you pay Rs. 1050 you can purchase one unit of Nifty. If we take 10 units by paying Rs. 1050 x 10 = Rs. 10500, we actually get one Nifty, that is also priced at Rs. 10500.
What is ETF Advantage?
So all ETFs can be taken in units and their prices are linked with the price and movement of the underlying. The best advantage of an exchange traded fund over a mutual fund is that it is listed in the exchange. So anytime it can be bought or sold. You need not to approach anyone, you just sell it, after 2 days money will automatically be credited to your trading account. Another advantage is it does not have any exit load. Some mutual funds have exit load, that means you need to pay some charges if you want to exit before a certain time. But no exchange traded fund is having exit load. No fund manager fees, no fund management charge is there in these funds.
A major use of ETFs is in the commodity markets. There can be ETF of Gold, Silver etc. The price of Gold ETF moves up with the price of Gold and also comes down with the price of Gold. If you purchase a Gold ETF, you are investing in Gold, but there is no making charges, no fear of theft, no vaults required. And you can sell it anytime to book your profit. To check what are the various types of exchange traded fund, you can check the National Stock Exchange site.
Indrajit is a professional blogger and trading system developer. Amibroker expert, WordPress expert, SEO expert and stock market analyst.Trading since 2002, he has started the journey of StockManiacs.net on 2008. He follows Indian and world stock markets closely.
Categories: Stock Market Basics