Skip to main content

Invest in ETF to diversify long-term portfolio

They can be bought and sold throughout a trading day like any stock


An exchange-traded fund (ETF) is a basket of securities that are traded on an exchange. They first came into existence in the US in the early 90s. Initially, these were looked upon with suspicion. However, of late, these funds have been attracting the interest of investors globally.


ETFs are different from mutual funds. ETF units are not sold to the public for cash. Instead, the asset management company that sponsors the ETF takes the shares of companies comprising the index from various categories of investors like authorized participants, large investors and institutions. In turn, it issues them a large block of ETF units. In case any dividend is accumulated for the stocks at any point in time, a cash component to that extent is also taken from such investors. A large block of ETF units called a 'creation unit' is exchanged for a 'portfolio deposit' of stocks and the 'cash component'.


Unlike regular open-ended mutual funds, ETFs can be bought and sold throughout the trading day like any stock. These funds rely on an arbitrage mechanism to keep the prices at which they trade roughly in line with the net asset values (NAV) of their underlying portfolios. In order to let the mechanism work, the potential arbitragers need to have full, timely knowledge of a fund's holdings.


ETF units are continuously created and redeemed based on investor demand. Investors may use ETFs for investments, trading or arbitrage. The price of the ETF tracks the value of the underlying index. This provides an opportunity to investors to compare the value of the underlying index against the price of the ETF units prevailing on the exchange. If the value of the underlying index is higher than the price of the ETF, the investors may redeem the units to the sponsor in exchange for the higher priced securities.


In case the price of the underlying securities is lower than the ETF, the investors may create ETF units by depositing the lower-priced securities. This arbitrage mechanism eliminates the problem associated with close-end mutual funds - premium or discount to the NAV.


The number of outstanding ETF units is not limited, as with traditional mutual funds. It may increase if investors deposit shares to create ETF units, or it may reduce on a day if some ETF holders redeem their ETF units for the underlying shares. These transactions are conducted by sending creation or redemption instructions to the fund. The portfolio deposit closely approximates the proportion of the stocks in the index together with a specified amount of cash component. This 'in-kind' creation/redemption facility ensures that ETFs trade close to their fair value at any given time.


Due to the unique structure of ETFs, all types of investors, whether retail or institutional, long-term or short-term, can use it to their advantage without being at a disadvantage to others. They allow long-term investors to diversify their portfolio at one go at low cost and insulates them from short-term trading activity due to the unique 'in-kind' c re at i o n / re d e m p t i o n process.


They also provide liquidity to investors with a shorter-term horizon as they can trade intra-day and can have quotes near NAV during the course of a trading day. As the initial investment is low, retail investors find it simple and convenient to buy/sell. They facilitate foreign institutional investors, institutional buyers and mutual funds to have easy asset allocations and hedging at a low cost. They also enable arbitrageurs to carry out arbitrage between the cash and futures markets at low impact costs.


Most ETFs charge lower annual expenses than index mutual funds. However, you have to pay a brokerage to buy and sell ETF units. This may turn out to be a significant drawback for those who trade frequently or invest regular sums of money. Many investors prefer to hold the creation units in their portfolios. Others may break-up the creation units and sell on the exchanges, where individual investors may purchase them just like any other shares.

Popular posts from this blog

National Savings Certificate

National Savings Certificate Here's everything you need to know about the 5-year savings scheme offered by the Government This is a 5-year small savings scheme of the government. From 1 July 2016, a National Savings Certificate (NSC) can be held in the electronic mode too. Physical pre-printed NSC certificates have been discontinued and replaced with Public Provident Fund-like passbooks. What's on offer The minimum amount you can invest in them is Rs100 and there is no upper limit. Under this scheme, all deposits up to Rs1.5 lakh qualify for deduction under section 80C of the Income-tax Act, 1961. The interest earned is taxable. You can invest in multiples of Rs 100. These certificates can be owned individually, jointly and also on behalf of minors. The interest rates for all small savings schemes are released on a quarterly basis. The effective rate for NSC from 1 October to 31 December is 8%. The interest is calculated on an annual compounding basis and is given along w...

Am you Required to E-file Tax Return?

Download Tax Saving Mutual Fund Application Forms Invest In Tax Saving Mutual Funds Online Buy Gold Mutual Funds Leave a missed Call on 94 8300 8300   Am I Required to 'E-file' My Return? Yes, under the law you are required to e-file your return if your income for the year is Rs. 500,000 or more. Even if you are not required to e-file your return, it is advisable to do so for the following benefits: i) E-filing is environment friendly. ii) E-filing ensures certain validations before the return is filed. Therefore, e-returns are more accurate than the paper returns. iii) E-returns are processed faster than the paper returns. iv) E-filing can be done from the comfort of home/office and you do not have to stand in queue to e-file. v) E-returns can be accessed anytime from the tax department's e-filing portal. For further information contact Prajna Capit...

Mutual Fund Review: HDFC Index Sensex Plus

  In terms of size, HDFC Index Sensex Plus may be one of the smallest offerings from the HDFC stable. But that has not dampened its show, which has beaten the Sensex by a mile in overall returns   HDFC Index Sensex Plus is a passively managed diversified equity scheme with Sensex as its benchmark index. The fund also invests a small proportion of its equity portfolio in non-Sensex scrips. The scheme cannot boast of an impressive size and is one of the smallest in the HDFC basket with assets under management (AUM) of less than 60 crore. PERFORMANCE: Being passively managed and portfolio aligned to that of the benchmark, the performance of the index fund is expected to follow that of the benchmark and in this respect, it has not disappointed investors. Since its launch in July 2002, the fund has outperformed Sensex in overall returns by good margins.    While every 1,000 invested in HDFC Index Sensex Plus in July 2002 is worth 6,130 now, a similar amount invested in Sensex then wo...

Different types of Mutual Funds

You may not be comfortable investing in the stock market. It might not seem like your cup of tea. But you can start by investing in Mutual Funds. Many first-time investors invest in Mutual Funds. This is because they do not know how to invest in individual securities. Basic information on Mutual Funds People invest their money in stocks, bonds, and other securities through Mutual Funds. Each Fund has different schemes with specific objectives. Professional Fund Managers look after these schemes. Your Fund Manager could help you invest in a scheme that suits your financial goal. Functioning of Mutual Funds You could make money through Mutual Funds in different ways. A single Mutual Fund could hold many different stocks, bonds, and debentures. This minimizes the risk by spreading out your investment. You could earn dividends from stocks and interest from bonds. You could also earn capital by selling securities when their price increases. Usually, you could choose to sell your share any t...

IDFC - Long term infrastructure bonds - Tranche 2

IDFC - Long term infrastructure bonds What are infrastructure bonds? In 2010, the government introduced a new section 80CCF under the Income Tax Act, 1961 (" Income Tax Act ") to provide for income tax deductions for subscription to long-term infrastructure bonds and pursuant to that the Central Board of Direct Taxes passed Notification No. 48/2010/F.No.149/84/2010-SO(TPL) dated July 9, 2010. These long term infrastructure bonds offer an additional window of tax deduction of investments up to Rs. 20,000 for the financial year 2010-11. This deduction is over and above the Rs 1 lakh deduction available under sections 80C, 80CCC and 80CCD read with section 80CCE of the Income Tax Act. Infrastructure bonds help in intermediating the retail investor's savings into infrastructure sector directly. Long term infrastructure Bonds by IDFC IDFC issued an earlier tranche of these long term infrastructure bonds on November 12, 2010. This is the second public issue of long-te...
Related Posts Plugin for WordPress, Blogger...
Invest in Tax Saving Mutual Funds Download Any Applications
Transact Mutual Funds Online Invest Online
Buy Gold Mutual Funds Invest Now