Overview: Exchange Traded Funds

Exchange Traded Funds are passively managed funds that track and try to imitate the returns of their benchmark.

Presently, passively managed funds are outstripping the actively managed funds and is being a tough challenger as the inflow of these funds is increasing substantially. As per the Association of Mutual Funds of India, the net inflow of passively managed funds (consists of Index funds, Gold ETF, Other ETFs and FoF investing Overseas) has significantly increased from an outflow of Rs 1,877.74 crore in October 2020 to an inflow of Rs 10,758.85 in October 2021. Besides, the net AUM of the same has surged from Rs 2,44,099.48 crore in October 2020 to Rs 4,49,185.82 crore in October 2021.

Evidently, from the above numbers, we come to know that there is substantial growth in these funds since last year.

Exchange-traded funds have features of both shares as well as mutual funds. In other words, ETFs are nothing but index funds traded on the stock exchange like any other individual stock. The net asset value (NAV) of ETFs fluctuates like any other stock. These can be bought and sold anytime you want on a real-time basis, unlike mutual funds. ETFs pool the capital invested by the investors in various assets like shares, bonds, etc, by mirroring its benchmark. Generally, ETFs are passively managed funds but presently ETFs are also actively managed. These actively managed ETFs are controlled by a portfolio manager, after assessing the stock market and investing in high potential companies whereas, passively managed ETFs track a particular market index. In order to invest in ETF, one should have a Demat account

What are Smart Beta ETFs? 

Smart Beta ETFs are the type of exchange-traded funds (ETF), which uses a rule-based, systematic approach in choosing stocks from a particular index. These types of ETFs are actively as well as passively managed. Passively managed funds track a specific underlying index, matching the return of the underlying index without having a professional manager, which leads to lower fees. On the other hand, actively managed funds are managed by the professional managers, who choose to invest in the stock to include in the portfolio, based on various fundamental metrics. Smart Beta ETFs might choose the companies that have certain behaviour or metrics. Smart Beta is nothing but factor funds or funds that are alternatively weighted indices (eg Equal weight index, factor-based, fundamentally weighted) unlike Nifty 50, which is a market-cap-weighted. Smart Beta ETFs offer better diversification and returns as well.

Benefits of investing in ETFs

 Diversification: ETF portfolio consists of various asset classes like equity shares, bonds, commodities, indices, which provide a diversified portfolio for investors. Purchasing shares of the company keeps limited to the performance of a particular company whereas ETFs invest in equity shares from various industries or if investors are willing to invest in one specific industry, the same can also be done by investing in an ETF.

Traded on the stock exchange: You can buy and sell an ETF during the market hours on a real-time basis. Any changes in the value can be noticed instantly whereas, in an open-ended mutual fund, value can only be determined after the market closes. The bottom line is that ETFs have higher liquidity than mutual funds.

Expense ratio is lower: The expense ratio in exchange-traded funds is quite low as compared to mutual funds. As ETFs are traded like normal stocks in the stock market, their expense ratio is considerably lower.
 

Taxation: In India, ETFs are taxed on the capital gains earned. Any short-term capital gains (STCG) earned from non-equity-oriented investment will be taxed as per income tax slab rate whereas STCG from equity-oriented investments will be taxed at the rate of 15%. Any long-term capital gain (LTCG) earned, arising from non-equity-oriented investments will be taxed at the rate of 20% with indexation whereas, LTCG from equity-oriented investments will be exempted up to Rs 1 lakh, while above Rs 1 lakh, it will be taxed at the rate of 10% without indexation.