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Exchange Traded Funds (ETFs) - Part 2

In this second part of the series about Exchange Traded Funds (ETFs), we look at the advantages and disadvantages of ETFs. As we have seen earlier in Part 1 , ETFs trade like shares while providing the diversification of managed funds.

Though they are similar to mutual funds, they differ in their diversification like index, commodities and different sectors. Their performance closely tracks the investment returns of the shares making up the index or the commodity they are invested into.


Benefits of investing in ETFs:

1. ETFs are passively managed, have low distribution costs and minimal administrative charges. Hence most ETFs have lower expense ratios than conventional Mutual Funds.
2. Not dependent on the fund manager, the ETF just tracks the index.
3. Like an index fund, they are very transparent.
4.Convenient to buy and sell as it can be bought/sold on the stock exchange at any time of the day when the market is open.
5.One can short sell an ETF or buy even purchase one unit, which is not possible with index-funds/conventional Mutual Funds.

Disadvantages of investing in ETFs:

1. Though most ETFs charge lower annual expenses than index mutual funds, as with stocks, one must pay a brokerage to buy and sell ETF units, which can be a significant drawback for those who invest regular sums of money.
2.SIP in ETF is not convenient as you have to place a fresh order with your stocks broker, every month.
3.Also SIP may prove expensive as compared to a no-load, low-expense index funds as you have to pay brokerage every time you buy and sell.
4.Because ETFs are conveniently tradeable, people tend to trade more in ETFs as compared to conventional funds. This unnecessarily pushes up the costs of investing.
5.Comparatively lower liquidity as the market has still not caught up on the concept.


ETFs in India:

In India, Benchmark Asset Management company was the first company to launch an index ETF - Nifty Bees and a Commodity ETF - Gold Bees (Surprisingly there isn't any Silver ETF, yet).There are other ETFs like Bank Bees, Infra Bees, etc., but they are illiquid and yet to catch the retail investors' fancy.

Hope, more and more investors come to know of such instruments and benefit from investing in them. To conclude, if an investor is looking for a long-term and defensive investment strategy in equities by backing the index rather than looking at active management, ETFs offer a good alternative to index-based funds.

Comments

  1. That was a well explained article.

    ReplyDelete
  2. AnonymousJune 10, 2014

    Hi, I am Rajesh. You have mentioned that "Though most ETFs charge lower annual expenses than index mutual funds...", my question is what are the annual expenses in case of ETFs? My understanding is that the only expense involved in ETFs are the buying and selling transaction costs like brokerage, STT, Stamp Duty etc. Please clarify what are the annual expenses.

    ReplyDelete
  3. AnonymousJune 10, 2014

    Hi, I am Rajesh. At one place, you have mentioned that Nifty Bees and Gold Bees were launched by Benchmark Asset Management company. ...whereas in some other articlaes you have mentioned that the Gold Bees is owned by Goldman Sachs. Are Goldman Sachs and Benchmark Asset Management company same entity or different entity? Please clarify.

    ReplyDelete
  4. @Yes, the expenses involved with ETFs are those you mentioned along with minimum administration charges. The annual expenses are limited between .6 to 1.5%.

    The traditional mutual funds or active funds, keep buying and selling which involve more costs than passive funds.Their expense ratio is about 2.5%.

    Benchmark funds launched the schemes initially and few years before Goldman took over. GS runs the fund now, but with the name as GS nifty bees etc..

    ReplyDelete

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