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5 reasons to invest in a wealth creating asset class: Exchange Traded Fund (ETF)

What are ETFs 

Product

  • collection of securities (typically stocks) that tracks an underlying index and trades in an exchange
  • can be stocks, gold, bonds, currencies, indices or other commodities

Trading

  • ETF trades in the stock exchange like any other stock and its prices fluctuate during the day; in stark contrast Mutual Funds (MF) NAV is updated end of day and does not trade

Operational ease

  • bought and sold through exchange; no financial intermediaries required
  • booking of intra-day profits to capture the movements in prices

Relatively lower cost

  • lower expense ratio and broker commissions compared to MFs; expense ratio in an equity MF is 1-2% whereas ETFs is less than 0.5% typically
  • for traders in futures market, haircut is less ~5% as ETF is low risk  vs. if mutual fund ~10-20% offered as collateral
  • less transaction charges (minimal/no exchange transaction tax, securities transaction tax, stamp duty in liquid based ETFs)

For a long-term investor, apart from the cost advantages, there are benefits like:

-Portfolio diversity (spread across sectors, indices, commodities),

-Liquidity (readily redeemable by selling in the market),

-Transparency (holdings are published daily with the prices)

The market for ETF in India is still evolving as Institutional investors (like EPFO, private trusts) contributes ~90% of the industry assets. ~70% of ETFs are in equity (mostly large-caps) while the balance is in gold, debt and commodities.

As incentives are low (distributor commission), such low-cost products have not been promoted well that comes with some unique merits.

With growing awareness amongst investors, HNIs and family offices have started to look at ETFs for growing their investments.

Performance

Looking at the performance of ETFs, 1Y returns have soared very high without a doubt as the financial markets have been on an upward trajectory over the last 12 months.

In Nifty, there are about 75 odd ETFs that are traded of which the most popular ones are NiftyBees (equity, mirrors Nifty returns) and LiquidBees (debt, invested in govt. securities). The main differences are below:

The return on LiquidBees is ~5.2%-7.4% over a 3Y annualised return whereas the NiftyBees yields higher as shown in the ETFs performance table previously.

Taxation

ETF dividends are added to the annual income of investor and taxable at IT slab rates as applicable.

ETF Equity Capital Gains are taxable as per the holding of the security:

Short-term <12 months (15%),

Long-term > 12 months (10%)

ETF Debt, Gold, International Capital Gains are taxable as per the holding of the security:

Short-term <36 months (applicable slab rates),

Long-term >12 months (20%) 

Here is a quick recap of the ease in investing in ETFs over MFs and its suitability to the retail investors, especially given the active MFs have been underperforming:

References:

www.moneycontrol.com

www.nseindia.com

www.groww.in

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Ramnath Sundar
Articles: 19

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