What are the Exchange Traded Funds(ETFs)?
How safe are they? How they perform?
Exchange-Traded Funds and Index Funds shorts:
What are ETFs?
How does it work?
Performance of ETFs
Factors to look at while buying ETFs.
Tax Treatment of ETF
What are ETFs?
An exchange-traded fund (ETF), just like a mutual fund is a basket of securities, but this is where the similarity with a mutual fund ends. Unlike a mutual fund, an ETF trades throughout the day on the stock exchanges. Exchange-traded funds pool the financial resources of several people and use them to purchase various tradable monetary assets such as shares, debt securities such as bonds, and derivatives.
Their units can be bought and sold directly on the exchange, through a stockbroker during trading hours. ETFs can be either close-ended or open-ended. Open-ended ETFs can issue fresh units to investors even post the new fund offer stage.ETFs can be either actively or passively managed. In an actively managed ETF, the objective is to outperform the benchmark index. On the contrary, a passively-managed ETF attempts to replicate the performance of a designated benchmark index. Hence it invests in the same stocks, which comprise its benchmark index and in the same weightage.
How does it work?
They are generally traded in the stock market in the form of shares produced via creation blocks. ETF funds are listed on all major stock exchanges and can be bought and sold as per requirement during the equity trading time.
Changes in the share price of an ETF depend on the costs of the underlying assets present in the pool of resources. If the price of one or more assets rises, the share price of the ETF rises proportionately, and vice-versa.
Actively managed ETFs are operated by a portfolio manager, after carefully assessing the stock market conditions and undertaking a calculated risk by investing in the companies with high potential. Passively managed ETFs, on the other hand, follow the trends of specific market indices, only investing in those companies listed on the rising charts
Types of ETFs
Equity ETFs
There are broadly 2 sub-categories of equity ETFs. You have your plain vanilla market-cap-weighted ETFs that track indices like the Nifty 50, Nifty 100, Sensex, etc. And then you have smart beta ETFs which target factors such as value, quality, low volatility, momentum, etc.Debt ETFs
We have debt G-sec ETFs, Bharat bond ETF which just holds bonds issued by PSUs, and then you have an ETF like the CPSE+SDL ETF by Nippon which holds PSU bonds and State development loans (SDLs).Commodity ETFs
For now, we just have gold ETFs.
When you buy or sell a stock, you are basing your transaction on the predicted performance of one company. When you buy or sell an ETF, you are basing your transaction on the predicted performance of multiple companies. When you buy or sell an index, you are actually buying shares in individual companies. With an ETF, you are buying shares in a portfolio of those companies.
List of all the ETFs available in the Indian Market :
To get more deep details and information about ETFs please visit the links in the resources section.
Performance of ETF?
The graph below shows the performance of NIFTY 50 over the years.
And this is the performance of NIFTYBEES ETF which follows the NIFTY 50 Index.
Factors to look at while buying ETFs.
What is Expense Ratio?
The expense ratio is the fee that mutual funds charge to manage your money, much like a physician who charges a fee for his service.
Expense Ratio = Operating Expenses/Average Value of Fund Assets
ETF Expense Ratio :
HDFC Nifty 50 ETF 0.05%
HDFC Sensex ETF 0.05%
ICICI Prudential Nifty ETF 0.05%
Nippon India ETF Nifty BeeS 0.05%
IDFC Nifty ETF 0.06%
Edelweiss ETF Nifty 50 0.07%
Nippon India ETF Sensex 0.07%
ICICI Prudential Sensex ETF 0.08%
ETFs do have a certain expense ratio, which is quite low when compared to mutual funds as the ETF products follow passive indexes which are not actively managed. The expense ratio is charged by the managing company and not by the broker. When you place the order for the ETF, the broker charges brokerage and not expense ratio. The expense ratio is deducted from your invested amount every day by the AMC. The NAV which you see has already factored in the expense ratio, you need not pay anything extra on top of it. When selling the units you will get a price for the units usually close to the NAV and once sold you will get the money credited.
What is NAV?
The net asset value (NAV) of an ETF represents the value of each share's portion of the fund's underlying assets and cash at the end of the trading day. ETFs calculate the NAV after the markets close.
The expense ratio is an indication of the amount that the fund house charges you for handling your investment portfolio and is expressed as an annual percentage. So, if you have made an investment of Rs.10,000 with an expense ratio of 1.5%, you will be paying Rs.150 to the fund house. If the fund grows by 10%, you will only receive 8.5% returns as 1.5% will be deducted as an expense ratio. If you are looking at a short-term investment, this amount may appear trivial but if you are making an investment for a period of say 15 years, this amount will get compounded. You will realize that you could have fetched higher returns if you had made the investment in a fund with a lower expense ratio.
It is deducted on a daily basis after calculating its per-day expense. The annual expense ratio is divided by the number of trading days of the year and is charged on the closing gross NAV
The expense ratio is charged by the issuer (asset management company) Even ETFs have a NAV. It is nothing but the total assets of the fund - liabilities/number of units. Every day when an asset management company declares the NAV, the expense ratio would have already been deducted.
The price you see on your trading platform is the market price, NAV is different from that. To check the NAV you will have to visit the respective AMC’s website. Here’s an example of Motilal ETFs:
Tracking error.
Tracking error is the annualized standard deviation of the difference between the ETF NAV returns and the index that it tracks. The net asset value (NAV) of an ETF represents the value of each share’s portion of the fund’s underlying assets and cash at the end of the trading day. In simple terms, it shows you how closely an ETF tracks its underlying benchmark. A simple example would be if Nifty 50 returned 10% and Nifty ETF gave 9.8%, the tracking error would be 0.2%. An ETF or an index fund will have lower returns than the index because they have an expense ratio and an index doesn’t.
A lower tracking error indicates that an ETF or an index fund is tracking the index better. But this is not really an intuitive measure to understand and we’ll discuss that later.
Tax Treatment
Tax treatment for capital gains earned from Equity ETFs
An equity ETF invests in equities or equity-related instruments. Hence, the tax treatment of capital gains made from these ETFs is similar to that of individual shares.
The tax rates are as follows:
LTCG – Not tax for capital gains up to Rs.100000. Any LTCG in excess of Rs.1 lakh will be taxed at 10% without indexation benefits (Section 112A of the Income Tax Act, 1961)
STCG – As per Section 111A of the Income Tax Act, 1961, STCG is taxed at 15% plus surcharge and applicable cess.
Tax treatment for capital gains earned from Debt ETFs, Gold ETFs, and International ETFs
While the tax on capital gains is different for equity investments, capital gains from debt, gold, and international ETFs are taxed in the same manner.
The tax rates are as follows:
LTCG – Any LTCG from debt, gold, or international ETFs will be taxed at 20% with indexation benefits
STCG – Any STCG from debt, gold, or international ETFs will be added to the investors’ annual income and taxed as per the applicable income tax slab rates
Use Screener to choose the best ETFs.
What I’m Buying, these are on my watchlist and will hold more than two or three ETFs in my portfolio for at least 5 years. See the 5-year CAGR and Expense Ratio.
Motilal Oswal NASDAQ 100 ETF has constituents of USA stocks like AMZ, GOOG, TESLA, AAPL, and more stock, a total of 100 stocks with a 5-year CAGR of 29.30% and 0.56 Expense ratio.
And most popular ETF in India is NIFTYBEES, which tracks the NIFTY50 stocks and performs accordingly with 5 Year CAGR of 17.17% and 0.05% Expense Ratio.
Sources:
https://groww.in/p/exchange-traded-funds/
https://zerodha.com/varsity/chapter/exchange-traded-funds-etf/
https://tradingqna.com/t/list-of-all-indian-exchange-traded-funds-etfs/47030/1
https://www.nseindia.com/market-data/exchange-traded-funds-etf
https://www.motilaloswal.com/blog-details/Beginners-Guide-to-Investing-in-ETFs/1547
https://groww.in/blog/how-to-choose-an-etf/
https://www.icicidirect.com/idirectcontent/Home/StaticData/WeOfferETFUnderstanding.html
https://www.blackrock.com/hk/en/ishares/education/what-is-an-etf
https://www.motilaloswal.com/blog-details/Why-Fund-of-Funds-(FOF)-and-ETFs-have-not-taken-off-in-India/1205
https://groww.in/blog/how-are-etfs-taxed/