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

Stick to Good Fund Manager who Can Multiply Your Investment

A manager may be the difference between the best and worst funds. Here's how you can find the right one    Does a mutual fund manager make a difference to your investment? The answer may not be as easy as you think, since most best-performing mutual funds have moved away from individualistic fund management to process-driven methods, limiting the scope of an individual's role in investment decisions. In fact, many fund managers would speak at length about how the "system" their fund house has in place makes their task of picking stocks easy even though it restricts their freedom. Still, the question is important, especially after recent reports that the Securities and Exchange Board of India ( Sebi ) may ask fund managers to disclose to investors their track record of managing money. Let us take a look at the universe of large-cap funds over the past five years. According to Value Research, an independent mutual fund tracking firm, the topper in the category is DSP...

Tata Fixed Income Portfolio Fund dividend

Invest In Tax Saving Mutual Funds Online Download Tax Saving Mutual Fund Application Forms Buy Gold Mutual Funds Call 0 94 8300 8300 (India)       Tata Mutual Fund has announced dividend under the dividend option of Tata Fixed Income Portfolio Scheme B2 Plan A-DQ, Tata Fixed Income Portfolio Scheme B2 Reg-DQ and Tata Fixed Income Portfolio Scheme B2 Direct-DQ. The record date has been fixed as August 29, 2013. Happy Investing!! We can help. Call 0 94 8300 8300 (India) Leave your comment with mail ID and we will answer them OR You can write back to us at PrajnaCapital [at] Gmail [dot] Com --------------------------------------------- Invest in Tax Saving Mutual Funds ( ELSS Mutual Funds ) to upto Rs 1 lakh and Save tax under Section 80C. Invest Tax Saving Mutual Funds Onlin...

NRIs and direct taxes code (DTC)

DTC Proposes To Do Away With Special Provision That Allows NRIs Liberalised Duration Of Stay In Country      THE new direct taxes code could bring a large number of global Indians under the tax net, as it does away with a provision that allowed individuals to escape tax in any country citing double tax avoidance.    The new legislation, introduced in Parliament on Monday, says an individual shall be a resident of India in any financial year if he is in the country for more than 59 days in that year, and has been has been India for more 365 days in four preceding financial years. A number of Indian industrialists including Vedanta's Anil Agarwal and Essar's Ravi Ruia have acquired non-resident status over the years.    The DTC has only attempted to clean up the provision in line with the laws globally. A phrase "being outside India" in the existing income tax law exempted individuals who stay outside the country for six months from paying taxes. This was prone ...

How to gauge the risk profile of your mutual fund portfolio?

MUTUAL funds are considered to be an investment option for those who do not generally devote a lot of time to monitoring and managing their portfolios. Investors experience both good as well as tough times as far as mutual fund investments are concerned. But while evaluating the portfolio of their equity mutual fund holdings there are a few points that one should check to know about the level of risk that they are facing. Often there are situations where there is a higher risk than what was estimated initially. Here are a few ways to evaluate various risk levels. Individual holding exposure : The portfolio of the equity fund where one has invested or plans to invest needs to be scrutinised to see whether the risk levels are such that could lead to a larger volatility in the holdings. Depending upon this factor and the risk taking ability of the investor the choice about a particular fund as an investment should be made. One key point to watch out is whether there is a large ex...

Health insurance guide - Part I

Insurance, by definition, is morbid. What if I die suddenly? What if my home caught fire? What if I had to undergo expensive medical treatment? What if something that I thought happened only to others befell me? Insurers, who work with large samples, calculate the probability of such an event and, hence, the possibility of them having to pay out a sum of money to mitigate, to the extent possible, the effects of that disaster. However, the possibility of you undergoing some kind of expensive medical treatment during your lifetime is far more likely than you dying suddenly or your house burning down. Given that costs at private healthcare facilities, where you are most likely to land up, is high, and, doubling every four years 10 months or so, the rest of your money life could easily go out of whack if you had to incur such expenses. Just 12 per cent of India's population is covered with some sort of health insurance. Pared to the bone, for a comparatively small price, health insu...
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