Title: ETFs vs Index Funds
1ETFs vs Index Funds
Ghazal Jain Associate Fund Manager, Alternative
Investments 24th Sept 2021
2Active Investing Passive Investing
Active Investing
Passive Investing
- Aim to beat the markets returns
- Active selection of securities, thus higher
expense ratio - Involves buying and selling of individual
securities or actively managed mutual funds
- Aim to track the markets performance
- No active decision in choosing securities , thus
lower expense ratio - Involves buying and holding Index funds and/or
ETFs
3What are ETFs?
3
- ETFs Exchange Traded Funds
- ETFs are passive instruments that closely track
an index
Graph is for indicative purpose only
4How do ETFs work?
4
- An ETF is a basket of securities
(stocks/bonds/gold) , units of which are sold on
an exchange - Investors can buy units of that basket, just like
buying shares of a company - Like mutual funds, ETF units represent partial
ownership of underlying basket of securities - Your investment in the ETF could increase or
decrease in value as the price of the underlying
stocks/bonds/gold changes - Like individual stocks, buyers and sellers trade
the ETF units throughout the day at prices that
change based on supply and demand
5The most common types of ETFs in India are
Equity ETFs track a particular index of stocks.
The index may be based on the companies
size, region, industry
Bond or Fixed Income ETFs track a portfolio of
corporate and/or government bonds
Gold ETFs track the price of gold
6Equity ETFs
ETFs track a particular index of
- They aim to track the price of the index and
mimic its returns
Stock A
Stock B
Stock C
CASH
50 stocks of Nifty Index
NIFTY ETF
ETF UNITS
Graph is for indicative purpose only
7Benefits of Equity ETFs
Better Diversification
Lower costs than Actively managed Mutual Funds
Tax efficiency
Flexible trading
Being passive products, they tend to have lower
expense ratios than actively managed mutual funds
8Gold ETFs
- Gold ETFs are Investment vehicles that invest in
physical gold
- They aim to track the price of gold and generate
returns in line with the returns of physical gold
CASH GOLD ETF ETF UNITS
Graph is for indicative purpose only
9Features of Gold ETFs
- Gold ETFs, even though a financial form, are very
real as each and every ETF unit is backed by 24
carat physical gold - Buying Gold ETFs means you are purchasing gold in
an electronic form. When you actually redeem Gold - ETF, you dont get physical gold, but receive the
cash equivalent - Just as shares represent the extent of equity
ownership in a company, units represent your
extent of - ownership in the ETFs underlying asset i.e. gold
- Gold ETF units are listed and traded on NSE and
BSE. You can buy and sell gold ETFs using a DEMAT
account just as you would trade in stocks - Gold ETFs combine the flexibility of stock
investment and the simplicity of gold investments
10Benefits of Gold ETFs
- Each and every ETF unit is backed by 24 carat
physical gold - Stored in accredited professional vaults
Investors do not have to worry about purity,
storage, and insurance of gold
Purity
- No making charges or high premiums
- Gold ETFs transfer benefit of wholesale purchase
prices to investors - Benefit of GST credit at Scheme level time of
selling gold - Traded close to the market price of physical
gold, with thin difference between buying
selling price
Price efficiency
Liquidity
- ETF units can be continuously bought and sold on
the NSE and BSE
- They offer investors a means of participating in
the gold market at low denominations of 1/2 gm
Accessibility
- You can purchase and sell online with a DEMAT
account from the comfort of your home
Convenience
Regulation
- Gold ETFs are regulated by SEBI
11Costs of an ETF
11
- Explicit Costs
- Expense ratio
- Brokerage commissions
- Implicit Costs
- Tracking error
- Bid-ask spreads
12What are Index Funds?
12
Passive mutual funds that copy performance of an
index like Sensex or Nifty
Hold same securities as index in same proportions
Buys or sells securities only when composition of
Index changes
13Benefits of Index funds
Better Diversification
Lower costs
Tax efficiency
14ETFs vs Index Funds
14
ETFs Index Funds
Investment Offers exposure to assets of a benchmark index Offers exposure to assets of a benchmark index
Management Passively managed Passively managed
Buy/Sell Can be bought or sold at real time NAV Can be bought or sold only at the end of the day at NAV
Liquidity Buy and sell on exchange Buy and sell with AMC only
Performance Similar to or lower than the benchmark index Similar to or lower than the benchmark index
Costs Expense ratio (0.1-0.5) Brokerage commissions Expense ratio (0.5-1.5)
DEMAT account Required Not required
SIP facility No Yes
15Limitations of ETFs and Index funds
15
- They dont offer flexibility to the fund manager
in managing market downsides - They simply mimic an underlying benchmark and
hence cannot generate alpha - Index funds lag their benchmark returns due to
the presence of tracking error
16Which passive investment should you opt for?
16
- While choosing between an ETF and index fund,
investors need to weigh the pros and cons of
both the passive avenues - Broadly, if you are seeking convenience, index
funds are likely to be the right choice - But if you want cost advantage and want to time
your entry and exit based on your - analysis of the markets, ETFs are likely to be
the better alternative - For both ETFs and Index funds, you should pick a
fund with minimum tracking error
17The choice should not be Active or Passive, it
should be Active AND Passive
- Large cap space efficient and widely covered
ETFs and Index Funds - Mid /small caps, Value style, ESG investing
Scope for active management
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