EXCHANGE TRADED FUNDS (ETF): PASSIVE WAY TOWARDS COMPOUNDING WEALTH

Jay Patel | 28 DEC 2022

What is Exchange Traded Funds (ETF)?

Exchange Traded Funds (ETF's), a unique product combination of stocks and mutual funds, are baskets of securities that tracks and replicates various indexes (such as Nifty50, BSE Sensex, Bank Nifty, Nifty IT), commodities (Gold and Silver) and bonds (Bharat bonds). ETF comprises of units like mutual funds and each unit is priced through Net-Asset Value (NAV). ETF as name suggests can be traded on NSE and BSE exchanges like individual stocks with much simplicity and faster execution. ETF's are often confused with Mutual funds but they both are different investment products.

ETF's are schemes/funds wherein many small and large investors invest their money passively and fund manager buys stock replicating benchmark indices such as NIFTY. ETF's may or may not outperform their benchmark indices but delivers returns in line with indices with some tracking error.

Types of ETF's:

1. Equity ETF - In Indian markets, Equity ETF mostly comprises of Indexes such as NIFTY 50, NIFTY Bank, SENSEX, NIFTY PSU Bank, NIFTY Next 50, S&P BSE Bharat 22 Index etc.
2. Gold ETF - Gold ETF invests in physical gold. When you buy Gold ETF units, investor is buying corresponding units of gold without risk of asset of asset protection.
3. Debt ETF - Debt ETF invests in various debt instruments including Government securities, debentures, bonds etc.
4. Currency ETF - This ETF invests in different currencies and provides return through currency fluctuations.

ETF: Passive Investment Tool

India launched its first ETF “Nifty Bees” in January 2022 which is listed in stock exchanges and can be traded like any other stocks. In last few years, there has been rush towards passive investment tools for retail investors. Currently, salaried professional and even regular investor wants to invest their savings into equities or gold through SIP's rather than traditional FD's. According to data, AUM of ETF assets in India touch 6.5 trillion in November.

ETF offers investors to earn market linked returns while eliminating behavioral and individual risks. Systematic Investing through Systematic Investment Plans (SIP's) in Nifty50 Index ETF's such as NIFTYBEES or lump sum investment during corrections would be an added advantage to your increase returns through passive investing strategy. It is noticed that majority of actively managed funds underperforms market and investors ends up paying higher management fees for underperforming investing while ETF's are very low cost product in terms of expense ratio. ETFs/Index funds overcome many behavioral and emotional risks which individual investor would encounter while investing. Let's take a look at Nifty BEES Vs. Nifty 50 Index returns from January 01st 2011 to December 26th 2022. Calendar year i.e. 01 Jan – 31st Dec is considered while calculating return:

We can clearly analyze Nifty Bees Outperformance over long term.

Let's say if investor has invested ₹ 100,000 in Nifty Bees on January 1st, 2011, his/her invested amount as on December 27, 2022 would amount to ₹ 318,793.30 excluding dividend giving 3x return in 12 years with CAGR of 10.14%. While ETF are passive investment tool but its applications are far reaching. ETF provides efficient trading exposure to investors who prefer to invest in specific sectors, index or asset class. Sometimes investors await right market condition for investment in individual stocks and till then ETF serves as right product to park investor's money helping to manage cash flows. ETF also serves as diversifying tool for investors with minimal capital. Thus, Exchange Traded Funds best suited for investors who wants a wet their feet into equities at lower cost and lower risk as compared to individual stocks.

Disclaimer: This article has been written by Jay Patel - Our Senior Research Analyst and originally published on Smart Investment website.