Friday, August 26, 2016

What is an Exchange Traded Fund?

An 'Exchange Traded Fund (ETF)' is special type of mutual fund. It closely mirrors popular stock indices like the 'BSE S&P Sensex' or 'NIFTY' or 'NIFTY Junior' and so on.

Every stock index comprises of select company shares in certain proportion or weigh  which is determined and disclosed by the index. The popular Sensex comprises of the top 30 companies by 'Market Capitalisation'. Once in a while the index is recast. A new company may replace an existing one.

Through an ETF instead of buying individual shares of a company you can buy the specific index itself. For example suppose you are interested in capturing the growth of the NIFTY, which constitutes the top 50 companies by market capitalisation of all the companies listed on the NSE, you have two options, as follows:

  1. You can keep track of the index yourself, buy the individual shares in the same quantity as the index and making necessary adjustments as and needed, based on the actual changes in the composition of the index, which is a tedious and time consuming process.
  2. Alternatively you can buy the ETF of the index you want to track. The drudgery is taken care of by the fund which created the ETF.
Here I present the various types of ETFs offered by Golaman Sachs in India:

Let us examine the composition of GS Nifty BeES.

The above picture depicts the composition of the GS Nifty BeES as on 1st August 2016.

 For the efforts taken to create and maintain the ETF, the sponsoring mutual fund charges a small annual maintenance fee, besides again reasonable purchase and redemption charges. The greatest advantage of an ETF is the low maintenance fees, usually less than 0.50% per annum. In contrast, mutual funds charge higher fees in the range of 1 to 2.25% per annum, besides the entry and exit loads.

The ETFs can be purchased just as you would purchase shares on the stock market. They are listed along side and among equity shares. This means it saves you the trouble of making an application form with the mutual fund for purchasing and redemption of units.

In conclusion, in my opinion ETFs are much better than mutual funds on account of ease of transaction, low charges as well as efficiency of long term wealth creation.

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