Exchange Traded Fund's (ETF's): Meaning, Types, Example, Advantages and Disadvantages

We always somewhere heard about ETF’s or Exchange Traded Funds, what mean exactly it? Now in this post we  clear concept of ETF’s and also go through its advantages and disadvantages with example of very famous ETF that is NIFTY 50.

Exchange Traded Funds (ETFs) are investment funds that are traded on stock exchanges, similar to individual stocks. They are a type of investment that allow investors to diversify their portfolio by investing in a basket of securities such as stocks, bonds, commodities, or a combination of these. Alternatively ETF’s is bundle of stock from similar or different categories, which are available for trading to investor. Like most of time we can not predict which stock out of available stock going to raise or fall and not have financial capacity to invest in all stock that time ETF’s are useful. It gives investor mobility to invest in index of particular sector with bunch of or bundle of shares at a time.

ETFs are structured as open-end investment companies or unit investment trusts (UITs). They pool together money from multiple investors and use it to buy a diversified portfolio of securities that match the investment objective of the ETF. Each share of an ETF represents a proportional ownership in the underlying assets of the fund.

The value of an ETF's shares is determined by the net asset value (NAV) of the underlying assets, which is calculated daily. ETFs are designed to track the performance of an underlying index, such as the Nifty 50, Bank Nifty, or BSE index fund. This means that the value of the ETF's shares will rise and fall in accordance with the index it tracks.

Here is an example: 

ETF traded on the National Stock Exchange (NSE) is the Nifty 50 ETF. The Nifty 50 ETF tracks the performance of the Nifty 50 Index, which is India's benchmark equity index and comprises the 50 largest and most liquid Indian companies listed on the NSE.

Here are some details about the Nifty 50 ETF:

Ticker symbol: The Nifty 50 ETF trades on the NSE under the ticker symbol "NIFTYBEES".

Fund manager: The Nifty 50 ETF is managed by ICICI Prudential Asset Management Company, which is one of the largest asset management companies in India.

Underlying index: The Nifty 50 ETF tracks the Nifty 50 Index, which is calculated by taking the free float market capitalization of the 50 largest companies listed on the NSE.

Portfolio holdings: The Nifty 50 ETF invests in the same 50 companies that are included in the Nifty 50 Index, such as Reliance Industries, HDFC Bank, Infosys, Tata Consultancy Services, and ICICI Bank, among others.

Expense ratio: The expense ratio of the Nifty 50 ETF is 0.05%, which is considered low compared to actively managed mutual funds in India.

Liquidity: The Nifty 50 ETF is highly liquid, which means it can be bought and sold easily throughout the trading day at market prices.

Tax efficiency: Like other ETFs, the Nifty 50 ETF is structured to be tax-efficient, as it can be redeemed "in-kind" rather than through cash payments, which helps to reduce capital gains taxes for investors.

Types of ETFs:

There are several types of ETFs available in the market, including:

Equity ETFs: These ETFs invest in stocks of companies in a particular sector or region, or those that meet specific criteria such as market capitalization, dividend yield, or growth potential.

Fixed Income ETFs: These ETFs invest in bonds, treasuries, or other fixed-income securities with different maturities, credit ratings, and interest rates.

Commodity ETFs: These ETFs invest in physical commodities such as gold, silver, oil, or agricultural products.

Currency ETFs: These ETFs invest in foreign currencies, allowing investors to hedge against currency risk or speculate on the movements of currency exchange rates.

Advantages of ETFs:

Diversification: ETFs offer investors the ability to diversify their portfolio by investing in a basket of securities, rather than just one stock or bond.

Low costs: ETFs typically have lower fees than actively managed mutual funds, as they are passively managed and have lower operating expenses.

Flexibility: ETFs can be bought and sold like individual stocks, which means investors can trade them throughout the day at market prices.

Liquidity: ETFs are highly liquid, which means investors can buy or sell them quickly and easily without affecting their market price.

Tax efficiency: ETFs are generally more tax-efficient than mutual funds, as they are structured as "in-kind" redemptions, which means they do not trigger capital gains taxes until they are sold by the investor.

Disadvantages of ETFs:

Tracking error: ETFs may not track their underlying index perfectly, which means they may underperform or overperform their benchmark.

Trading costs: While ETFs have lower fees than mutual funds, investors still have to pay commissions to their broker when buying or selling shares of an ETF.

Concentration risk: Some ETFs may be heavily invested in one sector or region, which means they may be more exposed to market fluctuations and economic conditions in that area.

Lack of active management: While passive management may be a benefit for some investors, others may prefer the active management provided by mutual funds.

Overall, ETFs offer investors a low-cost, flexible, and diversified investment option that can be used to complement or replace other investment vehicles in their portfolio. As with any investment, investors should carefully consider their investment goals, risk tolerance, and investment horizon before investing in ETFs.

Bank Nifty