ETF (Exchange Traded Fund) funds that are traded on stock exchanges Before understanding ETF, let’s understand what is fund.
What is Fund
Fund means the money collected from the people, the company that manages this fund is called the asset management company and the asset management company appoints the fund manager for that fund.
Fund managers invest that money according to the objective and goals of that fund. Whatever profit is made from that investment, it is shared among the people who had invested in that fund.
And to manage that fund, the asset management company charges some fee which is called the expense ratio.
What is ETF (Exchange Traded Fund)
In the cash market, you cannot buy indices like nifty, Sensex, Bank nifty, etc Because Nifty, Sensex is not a stock or fund, it is just an index that tells us the condition of the stock market or any specific sector.
Nifty includes 50 companies, which Nifty tells us the performance of those 50 companies.
The 50 companies included in the Nifty are well established and well-established companies with a good track record of different sectors.
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Therefore, from Nifty, we get to know the condition of the allover market. Whereas an ETF is a fund that replicates an index.
Let us understand with the help of an example as we have seen that 50 companies are included in Nifty and each stock has a different weightage in Nifty.
As of November, HDFC Bank has a 9.27% weightage in Nifty. Reliance Industries has 7.84% weightage, ITC has 5.69% weightage.
Similarly, other 47 companies also have different weightage, some less and some more. So Nifty’s ETF (Exchange Traded Fund) will buy shares of companies included in Nifty in the same proportion.
That is, in Nifty ETF, the fund manager will invest 9.27% money in HDFC Bank, 7.84% money will invest in Reliance Industries, 5.69% money will invest in ITC.
Similarly, the rest of the money will be invested in the remaining 47 companies according to the weightage they have in Nifty. So here Nifty ETF is completely following Nifty.
That is, investing in the same proportion in the stocks included in Nifty. With this, the performance of Nifty ETF (Exchange Traded Fund) will replicate the performance of Nifty.
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So as many returns Nifty will give, the same returns will be given by nifty ETF.
If nifty goes up then nifty ETF will also go up and if nifty goes down then nifty ETF will also go down.
On this side, by investing in ETF (Exchange Traded Fund) of Nifty-Sensex and some other indices, you can earn the same returns as those indices.
ETFs (Exchange Traded Funds) also trend on stock exchanges like stocks.
And due to supply and demand, the returns of ETFs do not exactly match the index that the ETF is replicating, meaning the returns of Nifty ETFs will not exactly match the returns of Nifty, they remain slightly up and down.
What is ETF Tracking Error
Assuming that Nifty gives 25% return and Nifty ETF fund gives 24.90% return then this difference is called tracking error. The lower the tracking error, the better.
According to fund management techniques, there are two types of funds:
- Actively managed funds
- Passively managed funds
Actively Managed funds
In actively managed funds, fund managers do research and pick stocks as per their choice and their aim is to ensure that the investors get the best returns according to the objective of the fund.
Passively Managed funds
In passively managed funds, the fund manager buys stocks in the same proportion as the index the fund is replicating.
Therefore, in passively managed funds, the fund manager does not need to research and pick stocks and hence the expense ratio of passively managed funds is much lower than actively managed funds.
ETF (Exchange Traded Fund) is a passively managed fund so the expense ratio of ETF is less than that of an actively managed fund.
What is Expense Ratio
Expense ratio means the annual fee of that fund through which that fund covers its operating expenses like management fees, marketing expenses, compliance, and administrative expenses, etc.
We see advertisements of a lot of ETFs (Exchange Traded Fund), must have seen ads for our Bharat 22 ETF recently. So these advertising expenses are also covered through the expense ratio.
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Talking about Bharat Bharat 22 ETF, the first s&p BSE Bharat 22 index was launched in August 2017. In which 22 companies of different sectors are included, out of which 19 are government and three private companies.
The weightage of these 22 companies in the Bharat 22 index is as follows:
| SR NO. | Company Name | Weightage |
|---|---|---|
| 1 | Axis Bank Ltd. | 7.82% |
| 2 | Bank of Baroda | 1.22% |
| 3 | Bharat Electronics Ltd. | 3.48% |
| 4 | Bharat Petroleum Corp Ltd. | 4.54% |
| 5 | Coal India Ltd. | 3.72% |
| 6 | Engineers India Ltd. | 1.44% |
| 7 | Gail India Ltd. | 4.25% |
| 8 | ITC Ltd. | 14.26% |
| 9 | Indian Bank | 0.21% |
| 10 | Indian Oil Corp Ltd. | 5.00% |
| 11 | Larsen & Toubro Ltd. | 16.92% |
| 12 | NBCC (India) Ltd. | 0.68% |
| 13 | NHPC Ltd. | 1.08% |
| 14 | NLC India Ltd. | 0.27% |
| 15 | NTPC Ltd. | 7.07% |
| 16 | National Aluminium Corp Ltd. | 5.13% |
| 17 | Oil & Natural Gas Corp Ltd. | 5.54% |
| 18 | Power Finance Corp Ltd. | 0.99% |
| 19 | Power Grid Corp of India Ltd. | 7.73% |
| 20 | Rural Electrification Corp Ltd. | 1.18% |
| 21 | SJVN Ltd. | 0.23% |
| 22 | State Bank of India | 7.25% |
l&t Axis Bank and ITC these three private companies have 39% weightage in Bharat 22 index and the rest 19 government companies have 61% weightage. What is now Bharat 22 ETF will replicate the s&p BSE Bharat 22 index.
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The government has selected ICICI Prudential assets management company to create and manage Bharat 22 ETF.
ETF is a tax-efficient product. When you hold an index ETF or sector-specific ETF for less than one year, you will have to pay a 15% short-term capital gain tax on your profits.
If you hold index ETFs or sector-specific ETFs for more than one year, then you will not have to pay any tax on your profits.
Demat account is compulsory for investing in ETFs.
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Assuming that Nifty gives 25% return and Nifty ETF fund gives 24.90% return then this difference is called tracking error. The lower the tracking error, the better.
According to fund management techniques, there are two types of funds:
1. Actively managed funds
2. Passively managed funds
Expense ratio means the annual fee of that fund through which that fund covers its operating expenses like management fees, marketing expenses, compliance, and administrative expenses, etc.
In actively managed funds, fund managers do research and pick stocks as per their choice and their aim is to ensure that the investors get the best returns according to the objective of the fund.
In passively managed funds, the fund manager buys stocks in the same proportion as the index the fund is replicating.