Exchange-traded funds

What are exchange-traded funds (ETFs)?  

Exchange-traded funds have features of both shares as well as mutual funds. ETFs are basically index funds traded on the stock exchange like any other individual stock. The net asset value (NAV) of ETFs fluctuates like any other stock. These can be bought and sold anytime you want, unlike mutual funds. ETFs pool the capital invested by the investors in various assets like shares, bonds, etc. They can be managed actively as well as passively. Actively managed ETFs are controlled by a portfolio manager, after assessing the stock market and investing in high potential companies whereas, passively managed ETFs track a particular market index.   

Benefits of investing in ETFs  

 Diversification: ETF portfolio consists of various asset classes like equity shares, bonds, commodities, indices, which provide a diversified portfolio for investors. Purchasing shares of the company keeps limited to the performance of a particular company whereas ETFs invest in equity shares from various industries or if investors are willing to invest in one specific industry, the same can also be done by investing in an ETF.   

Traded on the stock exchange: You can buy and sell an ETF during the market hours on a real-time basis. Any changes in the value can be noticed instantly whereas, in an open-ended mutual fund, value can only be determined after the market closes. With this, we come to the conclusion that ETFs have higher liquidity than mutual funds.  

Expense ratio is lower: The expense ratio in exchange-traded funds is quite low as compared to mutual funds. As ETFs are traded like normal stocks in the stock market, their expense ratio is considerably lower.  

Taxation: In India, ETFs are taxed on the capital gains earned. Any short-term capital gains (STCG) earned from non-equity-oriented investment will be taxed as per income tax slab rate whereas STCG from equity-oriented investments will be taxed at the rate of 15 per cent. Any long-term capital gain (LTCG) earned, arising from non-equity oriented investments will be taxed at the rate of 20 per cent with indexation whereas, LTCG from equity-oriented investments will be exempted up to Rs 1 lakh while above Rs 1 lakh, it will be taxed at the rate of 10 per cent without indexation.  

What are Smart Beta ETFs?  

Smart Beta ETFs are the type of exchange-traded funds (ETF), which uses a rule-based, systematic approach in choosing stocks from a particular index. These types of ETFs are actively as well as passively managed. Passively managed funds track a specific underlying index, matching the return of the underlying index without having a professional manager, which leads to lower fees. On the other hand, actively managed funds are managed by the professional managers, who choose to invest in the stock to include in the portfolio, based on various fundamental metrics. Smart Beta ETFs might choose the companies that have certain behaviour or metrics. Smart Beta is nothing but factor funds or funds that are alternatively weighted indices (e.g. Equal weight index, factor-based, fundamentally weighted) unlike Nifty 50, which is a market-cap-weighted. Smart Beta ETFs offer better diversification and returns as well.