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Exchange Traded Funds
[Submitted by CA. Vibhuti Gupta,
Chartered Accountant,
New Delhi]
April 1, 2008
Exchange Traded Funds (ETF) is defined as a security that tracks an
index, a commodity or a basket of assets like an index fund but trades
like a stock on an exchange and experiences price changes throughout the
day as it is bought and sold. ETF were first launched in 1993 in United
States. Their popularity as a structured product has grown immensely
because of the benefits it provides to investors and traders. The issuance
of EFT is just like a primary market IPO or a mutual Fund NFO. Shares are
issued by the Fund manager and listed on the exchanges. Investors can buy
and sell these shares from the secondary market through their brokers. ETF
are often called as index shares, are a hybrid of index
The advantages of a Traded fund shares are :
- Tradable and diversifiable: ETF offer a unique advantage as they are
diversifiable like mutual funds and also can be traded like stocks.
Mutual funds cannot be traded each day like a stock
- Low cost: ETF like an Index fund does not require active fund
managed and is therefore cheaper as passively managed.
- Transparency: ETF is a very transparent instrument, as everyone
knows the underlying asset.
- Makes multiple trading strategies possible: Arbitrage opportunities
between cash and futures market can be availed at low cost. Trading
strategies can be applied
with stop loss orders.
The disadvantages are:
- Broker and commission costs: ETF are traded through brokers and
hence every time brokerage has to be paid which becomes costly affair if
regular trades are done.
- Premiums and discounts: An ETF might trade at a discount to the
underlying shares. This means that although the shares might be doing
very well on the bourses, yet the ETF might be traded at less than the
market value of these stocks.
Difference between ETF & Mutual Funds :
ETF Comparison - While similar to an index mutual fund, ETFs
differ from mutual funds in significant ways.
| Attribute |
ETF |
Index Mutual Fund |
Individual Stock |
| Diversification |
Yes |
Yes |
No |
| Traded throughout the day |
Yes |
No |
Yes |
| Can be bought on margin |
Yes |
No |
Yes |
| Can be sold short |
Yes |
No |
Yes |
| Tracks an index or sector |
Yes |
Yes |
No |
| Tax efficient as turnover is low |
Yes |
Possibly |
No |
| Low Expense Ratio |
Yes |
Sometimes |
Not a factor |
| Trade at any brokerage firm |
Yes |
No |
Yes |
Gold ETFs
In a gold crazy country like India, Gold ETF is sure has the potential
to emerge as a popular investment product. A gold-exchange traded fund
unit is like a mutual fund unit backed by gold as the underlying asset and
would be held mostly in demat form. An investor would get a securities
certificate issued by the mutual fund running the Gold-ETF defining the
ownership of a particular amount of gold. GETFs are designed to offer
investors a means of participating in the gold bullion market without the
necessity of taking physical delivery of gold, and to buy and sell through
trading of a security on a stock exchange.
With gold being one of the important asset classes, GETFs will provide
a better, simpler and affordable method of investing as compared to other
investment methods like bullion, gold coins, gold futures, or jewellery.
India currently has five gold Exchange Traded Funds listed on the
National Stock Exchange, including Reliance Gold Exchange Traded Fund,
Gold Benchmark BeEs, UTI Gold Exchange Traded Fund, Kotak Gold ETF and
Quantum Gold Fund.
Advantages of GETFs
- No risk of holding physical stock: As GETFs are issued in
demat form, the risk associated with holding physical gold is reduced
considerably.
- Affordable: GETFs are ideal for small retain investors as
they can buy a just one unit from the exchange. The minimum amount of
investment during the NFO period for Cash is Rs 10,000 and in multiples
of Rs 1,000 thereafter. One unit of the fund will represent one gram of
gold.
- High Liquidity: GETFs can be easily bought / sold like any
other stock on the exchange during market hours at real-time prices as
opposed to end of day prices.
- Lower cost: GETFs enjoy the benefits of lower cost and higher
transparency. As they are listed on the exchange, costs of distribution
are much lower. Further, exchange traded mechanism helps reduce minimal
collection, disbursement and other processing charges. Gold futures
include the cost of carry that will be absent on a GETF.
- Low tracking error: Tracking Error of GETFs is likely to be
low as compared to a normal fund. Due to the creation / redemption of
units only through in-kind mechanism the fund can keep lesser funds in
cash. Also, time lag between buying / selling units and the underlying
physical gold is much lower.
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