ETF Investing is Passive Investing which essentially means your fund is mimicking its benchmark index. ETFs include a basket of securities that mirror the target benchmark. However, units of an ETF are listed and traded via stock exchanges like any other security.
SO there is no fund manager expertise involved in the same. As the name suggests the units are traded on the exchange so the one you invest you can exit by selling units in the exchanges it is being traded.
ETF Investing is gaining popularity in India because of the government Divestment Program through ETF and Allowing Pension Funds to Invest into Equities through ETFs. One more reason for rising investing interest in ETF is recent poor returns from Active Funds.
The Salient Feature of ETFs are :
- Selling on Exchange: As units are traded on exchanges, there is no exit load while redeeming the units.
- Low Cost: The expense ratio of ETFs is the lowest.
While Selecting an ETF for your Portfolio, you need to consider the following parameters ;
- Fund Category i.e Largecap or Small Cap or Globa Index vis-a-vis your asset allocation and choose fund that matches with your asset Allocation
- Tracking Error: Returns of passive funds are almost on par or marginally lower compared to their respective benchmarks. Tracking errors represent the difference between benchmark return and the return delivered by the passive fund. The lower this number, the better. These errors arise because of 2 reasons – cash drag, allocation mismatch.
- Cash drag: Passive funds hold about a certain percentage of their AUM in liquid assets for redemption requests. The uninvested portion is allocated to money market instruments, which in turn reduces the exposure of the passive fund to the underlying benchmark index. As such, the passive funds may not be able to replicate the performance of the underlying benchmark perfectly, which is akin to a “drag” in performance.
- Allocation Mismatch: If a passive fund fails to allocate its AUM in the same manner as the benchmark’s constituents, returns of the fund may not replicate those of the benchmark.
- Expense Ratio: The expense ratio is what investors pay annually, to cover the various operating expenses and management of the funds, such as management fees, administration costs, custodian costs, as well as audit and legal fees. They are expressed as a percentage of a fund’s average net assets. For regular plans of mutual funds, the expense ratio includes the distribution costs, i.e. the commissions paid to distributors. The lower the expense ratio, the higher the total return. Thus, the expense ratio is one of the most important criteria in our selection process.
- Trading Volume: There is minimal liquidity concern for MF unitholders of index funds as they can sell to or buy units from the fund houses. In contrast, in the case of ETFs, units of the fund can be only traded via the stock exchange. So, if an individual holding 100 units in an ETF wishes to sell them on an exchange, he may not be able to do so if there is no buyer to meet the desired price. Therefore, it is crucial to look at traded volumes of such ETF’s units on the exchanges to assess the degree of liquidity (ie. the ease with which units can be purchased/sold with minimal price impact).
To help you and other readers, I am posting two lists of ETFs, first one is the Recommended List of ETFs from IFAST, and the second one is from DSIJ.
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