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An Overview of Exchange Traded Funds

Exchange traded funds are financial instruments that track an index or a sector or a commodity or any other asset and can be sold or purchased on a stock exchange. These funds are structured to track the price of an individual commodity like gold or silver or a large and diverse collection of securities and, in some cases, even specific investment strategies.  

These funds are registered with the Securities and Exchange Board of India and offer new investors a good chance to participate in the markets. The top performing mutual funds in India include funds that invest in equity or gold or commodities. 

Things to Know About Exchange Traded Funds

A commonly asked question by investors is What are exchange traded funds– stocks or mutual funds? These instruments are neither stocks nor mutual funds, but lie somewhere in between.

Here are some important features of ETFs:

  • They are marketable and can easily be bought and sold like stocks on the stock exchanges.
  • They differ from mutual funds, which are not traded on an exchange and trade only once per day after the market closes.
  • They can hold not one but several underlying assets
  • They may invest only in one segment or a diverse set of stocks
  • The changes in the price of an ETF will depend on the cost of the underlying assets. If the price of one or more assets held by the fund rises, the share price of the ETF rises proportionately.
  • The value of dividend received by ETF holders will depend on the performance of the asset management company.
  • They can be actively or passively managed. In the case of the former, the asset management company or the portfolio manager invests after a careful analysis of the market situation. In the case of passively managed ETFs investment is based on the trends in the specific market indices. 

Types of ETFs

Exchange traded funds are preferred by investors for income generation, speculation and hedging purposes. Some common types of ETFs are:

  • Debt ETFs – These funds invest in different types of debt instruments or government bonds, corporate bonds and municipal bonds.
  • Industry/Segment ETFs – These funds track a specific industry such as IT, banking, power or oil and gas.
  • Commodity ETFs – These funds invest in commodities such as crude oil or gold.
  • Currency ETFs – These funds invest in foreign currencies.
  • Inverse ETFs – This category of ETFs aims to earn from the decline in stock prices by shorting or selling a stock in expectation of a decline in its value and then repurchase it at the lowered price.

Benefits of Investing in ETFs

ETFs are top performing mutual funds that offer several benefits:

  • They are cheaper since they can be bought and sold from the market. Charges like entry and exit load and the management fee associated with mutual fund investments are not applicable.
  • Changes in the value of an ETF are visible instantly unlike other mutual funds whose value is dependent on the Net Asset Value or NAV.
  • They allow investors to diversify their holdings.

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Written by Aabidaha Shaikh