ETFs, or exchange-traded funds, are collections of investment assets. ETFs track the underlying index so they will include the same stocks as their benchmark index in the same proportion. The benchmark index is a standard index against which the performance of the scheme is measured. For example, a Nifty 50 index contains the stocks of the top 50 companies in India based on market capitalization.
Over the past few years, ETFs have grown in popularity and as a choice of investment. You too should consider investing in ETFs as a part of your investment decisions.
Some of the factors you should consider
before investing are: -
1. Get to know your investment goal and time horizon
Before investing in ETFs, knowing your investment goal and horizon is important. Also, it is essential to assess your risk appetite for it. Knowing this can help you invest in the right ETF that aligns with your goals. There are many ways in which you can assess your risk profile. One of the things you can do is assess your investment horizon, whether it is short-term or long-term. If you are looking for long-term investment, you could look for equity-related instruments and if your aim is short-term investments then you could explore Liquid ETFs which are high in liquidity.
2. Understanding the Types of ETFs that are available
Once you know your investment goals and risk appetite, you can choose the type of ETF for investment. There are three main types of ETFs you can invest in.
Just as its name, equity ETFs track the underlying broad market indices, such as S&P BSE Sensex and NSE Nifty 50.
Commodity ETFs invest in tangible assets like silver and gold. Now, when you redeem such ETFs, you receive their cash equivalent instead of the physical commodity.
Invest in short-term maturity instruments such as Tri-Party Repos (TREPS*), and other money market instruments like certificates of deposits, commercial papers, treasury bills, etc.
3. Knowing the Benchmark index
Since ETFs aim to mirror the stock profile of a benchmark index in precisely the same proportion, this makes it one of the transparent investment products easily accessible by all investors. For instance, a Nifty 50 Value 20 ETF will offer the same 20 stocks as its corresponding NSE index. Hence, one can identify the stocks in the ETF profile by looking at the stocks that are part of the benchmark index.
It also helps the investors zero down on a particular ETF for investment that aligns with their goals.
4. Expense ratio of the ETF scheme
An ETF’s expense ratio or Total expense ratio (TER) can be defined as the annual charges of the fund, including operating expenses, management charges, administrative charges, and more. One of the key defining features of an ETF is its lower expense ratio, as these are passively managed funds. A passively managed fund follows a passive investment strategy. It tracks a market index to decide where to invest in against an actively managed fund that involves a fund manager who decides where to invest in. This brings out several advantages to the investors in the form of diversifying their portfolio at lesser costs. So, you can assess which fund has a lower expense ratio while investing in ETFs.
5. Tracking error
Tracking error represents the difference in performance between the fund and its benchmark. A lower tracking error indicates that the ETF closely follows the movements of its benchmark, while a higher tracking error suggests a greater deviation in performance. Investors typically prefer ETFs with low tracking error, as it indicates a more accurate replication of the benchmark's performance. However, it's important to note that some level of tracking error is inevitable due to various factors. Investors should refer to SID for tracking error related risk factors.
6. ETFs composition
This means the stocks/asset that the ETF is comprised of which will be the same as its underlying index. Hence any change in the benchmark index will also bring a change in the composition of the ETF that is tracking that particular benchmark.
7. Market Volatility also plays a role
Investors mostly prefer ETFs because it offers portfolio diversification and hedges the risk to some extent. However, there are still certain risks associated with ETFs. These risks are primarily dependent on the ETFs composition and focus. Equity ETFs tend to be more volatile than debt ETFs since they are relatively riskier instruments.
8. Sector exposure
Sector ETFs focus on exposing investors to specific stocks of a particular sector or industry, such as pharmaceuticals, oil, and more. For example, ETFs that track the Nifty Auto or Nifty FMCG indices are sectoral ETFs. These ETFs tend to be riskier than the market indices since there is a sector concentration. However, investors looking for a long-term investment could explore sector ETFs as an investment option. One can also read through the Scheme Information Document (SID) for detailed information about these schemes.
ETFs combine a diverse portfolio's flexibility with the ease of trading just like stocks. Whether you are a beginner or an experienced investor, assessing the factors mentioned earlier before investing in ETFs can help you make an informed decision so that your investment attune to your investment goals.
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Visit www.icicipruamc.com/note to know more about the process to complete a one-time Know Your Customer (KYC) requirement to invest in Mutual Funds. Investors should only deal with registered Mutual Funds, details of which can be verified on the SEBI website http://www.sebi.gov.in/intermediaries.html For any queries, complaints & grievance redressal, investors may reach out to the AMCs and/or Investor Relations Officers. Additionally, investors may also lodge complaints on https://scores.gov.in if they are unsatisfied with the resolutions given by AMCs. SCORES portal facilitates you to lodge your complaint online with SEBI and subsequently view its status.
Mutual Fund investments are subject to market risks, read all scheme related documents carefully.