Exchange-traded funds (ETFs) are investments that track the performance of a basket of securities, such as stocks, bonds, commodities, or indices. ETFs are traded on stock exchanges like regular shares and offer investors a convenient and cost-effective way to diversify their portfolios and access various markets. We are discussing ETF investing in India, why do people invest in ETFs in India?
ETF investing in India has become increasingly popular, as the country’s economy and financial sector have grown and developed over the years. According to the Association of Mutual Funds in India (AMFI), the assets under management (AUM) of ETFs in India reached Rs. 2.18 lakh crore as of February 2023, a 43% increase from the previous year.
But what are the benefits and risks of investing in ETFs in India? In this blog post, we will explore some of the advantages and disadvantages of ETFs, and how you can choose the best ETFs for your investment goals and risk appetite.
Benefits of ETF Investing in India
Some of the benefits of ETF investing in India are:
- Low cost: ETFs typically have lower expense ratios than actively managed mutual funds, as they do not require fund managers, research analysts, or other intermediaries. ETFs also have lower transaction costs, as they are traded on stock exchanges and do not incur entry or exit loads. For example, the average expense ratio of equity ETFs in India is 0.25%, while the average expense ratio of equity mutual funds is 2.08%.
- Diversification: ETFs allow investors to diversify their portfolio across various asset classes, sectors, themes, and geographies, with just one or a few transactions. ETFs can also reduce the risk of concentration and volatility, as they are less affected by the performance of individual securities. For example, an investor can invest in a Nifty 50 ETF, which tracks the performance of the 50 largest and most liquid companies in India, and gain exposure to different sectors and industries.
- Transparency: ETFs disclose their holdings and NAVs daily, unlike mutual funds, which disclose them on a monthly or quarterly basis. This gives investors more clarity and confidence about what they are investing in, and how their ETFs are performing. ETFs also have a close correlation with their underlying index or asset, as they use various mechanisms to ensure that their market price does not deviate significantly from their NAV.
- Liquidity: ETFs are traded on stock exchanges throughout the day, unlike mutual funds, which are traded only at the end of the day. This gives investors more flexibility and control over their investment decisions, as they can buy and sell ETFs at any time, and at the prevailing market price. ETFs also have high liquidity, as they are backed by market makers and authorized participants, who ensure that there is enough supply and demand for ETFs in the market.
Risks of ETF Investing in India
Some of the risks of ETF investing in India are:
- Market risk: ETFs are subject to the same market risk as their underlying securities, and can fluctuate in value due to various factors, such as economic conditions, political events, corporate actions, or natural disasters. ETFs are not guaranteed to match the performance of their underlying index or asset and can have tracking errors, which are the differences between the returns of the ETF and the index or asset. ETFs can also have tracking difference, which is the difference between the total return of the ETF and the total return of the index or asset, after accounting for fees, dividends, and taxes.
- Liquidity risk: ETFs are dependent on the liquidity of their underlying securities, and can face liquidity issues if the securities are illiquid, thinly traded, or suspended. ETFs can also face liquidity issues if there is a lack of market makers or authorized participants, who facilitate the creation and redemption of ETF units. In such cases, ETFs can trade at a significant premium or discount to their NAV, and investors can face difficulties in buying or selling ETFs at their desired price or quantity.
- Regulatory risk: ETFs are subject to the regulatory framework and guidelines of the Securities and Exchange Board of India (SEBI), which can change from time to time. ETFs can also be affected by the tax laws and policies of the government, which can have implications for the returns and taxation of ETFs. For example, in the Union Budget 2023, the government introduced a 10% long-term capital gains tax on equity and equity-oriented funds, including ETFs, for gains exceeding Rs. 1 lakh in a financial year.
How to Choose the Best ETFs Investing in India?
There are various types of ETF investing in India, such as equity ETFs, debt ETFs, gold ETFs, international ETFs, sectoral ETFs, thematic ETFs, and smart beta ETFs. Each type of ETF has its features, benefits, risks, and suitability for different investors.
To choose the best ETFs in India, investors should consider the following factors:
- Investment objective: Investors should have a clear idea of their investment objectives, such as capital appreciation, income generation, or hedging. They should also have a realistic expectation of the returns and risks of ETFs, and align them with their objective.
- Investment horizon: Investors should have a long-term investment horizon for ETFs, as they are subject to market fluctuations and volatility in the short term. They should also consider the impact of fees, dividends, and taxes on their returns over time.
- Risk appetite: Investors should assess their risk appetite, or their willingness and ability to tolerate losses. They should also consider the risk profile of the ETFs, such as the volatility, tracking error, tracking difference, and liquidity risk, and choose the ETFs that match their risk appetite.
- Cost efficiency: Investors should compare the expense ratios, transaction costs, and tax implications of different ETFs, and choose the ETFs that offer the best value for money. They should also consider the impact of compounding on their returns, and avoid frequent buying and selling of ETFs, which can erode their returns.
- Performance: Investors should evaluate the past performance of the ETFs, and compare them with their benchmark index or asset, and with their peers. They should also consider the consistency, stability, and reliability of the performance, and not chase the highest returns or the lowest fees.
- Quality: Investors should check the quality and reputation of the ETF provider, the index provider, and the fund manager. They should also check the portfolio composition, diversification, and liquidity of the ETFs, and avoid the ETFs that have high concentration, low liquidity, or complex structures.
Common FAQs about ETF Investing in India:
1. What are the different types of ETFs available in India?
There are several types, including:
- Index ETFs: Track a specific index like Nifty or Sensex, offering broad market exposure.
- Gold ETFs: Invest in physical gold, good for diversification and hedge against inflation.
- Sector ETFs: Focus on specific sectors like IT or infrastructure, for targeted exposure.
- Bond ETFs: Invest in a basket of bonds, offering stable income and diversification.
- International ETFs: Track foreign indices or invest in global themes.
2. What are the benefits of ETF investing in India?
- Diversification: Spread your risk across various stocks/assets.
- Lower costs: Typically lower expense ratios than actively managed funds.
- Convenience: Trade-like stocks, offering flexibility and transparency.
- Tax efficiency: Generally lower capital gains compared to mutual funds.
3. What are the risks of ETF investing in India?
- Tracking error: ETF performance might not perfectly match the underlying index.
- Liquidity risk: Some ETFs might have low trading volumes, making entry/exit difficult.
- Market risk: Overall market fluctuations can impact ETF value.
- Limited control: You passively follow the index, with no individual stock picking.
4. How much should I invest in ETFs?
It depends on your goals, risk tolerance, and overall portfolio. Consider seeking financial advice for personalized recommendations.
5. What are the tax implications of ETF investing in India?
Capital gains tax applies on profits earned from selling ETFs. Consult a tax advisor for specific details.
6. Where can I buy and sell ETFs in India?
You can invest through most demat accounts offered by brokers and online platforms.
7. How do I choose the right ETF for me?
Consider your investment goals, risk tolerance, desired asset class, and expense ratio. Research specific ETFs and compare them before investing.
8. Are there any online resources for learning more about ETFs?
Yes, many financial websites and blogs offer information about ETFs in India. Government websites like SEBI also provide educational resources.
ETF investing in India is a great way to invest, as it offers low cost, diversification, transparency, and liquidity. However, ETFs also have some risks, such as market risk, liquidity risk, and regulatory risk, which investors should be aware of and prepared for. Investors should also do their homework and research before investing in ETFs, and choose the ETFs that suit their investment objective, horizon, risk appetite, cost efficiency, performance, and quality.