Types of ETFs in India: Find the Best for Your Investment

In the world of financial markets, ETFs have gained popularity rapidly among investors, who prefer passive investment options with a diversified basket of assets at a low cost. Seasoned investors are aware of the types of ETFs, but there are various new investors who are unaware of the different types of ETFs. 

In this blog, we will explain the types of ETFs in India and tell you which ETF is best for you. 

What is an ETF?

An ETF or Exchange Traded Fund is an investment tool that primarily trades on the stock exchange and invests in a particular index or a mix of securities such as stocks, bonds, or commodities. They are traded like any other stock on the exchange; therefore, to invest in them, one is required to have a demat and trading account. They are passively managed; hence their returns closely resemble the performance of a specific index that it follows.

Features of ETF

The key features of ETFs are as follows:

1. Passive Fund: ETFs passively track the index and try to replicate its performance.
2. Pool of Securities: ETFs invest in a basket of securities, which helps an investor diversify their portfolio and reduce market risk.
3. Transparency: ETFs generally disclose their holdings daily, therefore, investors get a clear picture of what they hold in their portfolios.
4. Demat Account: ETFs are generally traded on the stock exchange. Therefore, it is mandatory to have a demat and trading account to invest in them.
5. Low Cost: As ETFs are passively managed funds; therefore they have lower fees when compared to actively managed funds, making them a cost-effective investment option.
6. Liquidity: ETFs are traded on the stock exchange and have higher volume, making it easy for buyers and sellers to execute their trades.

Read Also: How to Invest in ETFs in India – A Beginner’s Guide

How does an ETF work?

Understanding the workings of an ETF is very easy. ETFs are managed by Asset Management Companies, which pool money from various investors who have similar investment objectives and invest the pooled money into a basket of assets. They try to replicate the performance of an underlying asset, such as an index etc. In return, they charge a small fee from the investors. As they are passively managed, therefore, their returns are similar to an index in which it has invested its capital. They are listed on the exchange and provide liquidity to investors. The market price of ETFs changes during trading hours, and one can easily buy and sell them at the current market price.

Different Types of ETFs

There are six types of ETFs available in India, details of which are mentioned below:

1. Equity ETFs

These ETFs invest primarily in stocks and track the movement of particular equity indices, such as the Nifty 50, Bank Nifty, etc. It particularly invests in the basket of stocks in the same proportion as the particular index consists.

Example: Kotak Nifty ETF invests in the top 50 companies based on market capitalisation that are part of the Nifty.

2. Fixed Income ETF

Fixed Income ETFs are also known as bond ETFs; they invest your money in fixed income securities, and provide you a steady return. They are comparatively less volatile and risky than equity-oriented ETFs.

Example: Bharat Bond ETF, which primarily invests in AAA-rated bonds and government securities.

3. Commodity ETF

The ETFs which invest in commodities such as gold, silver, etc. are known as commodity ETFs. The returns of these ETFs are based on the fluctuations in the underlying commodity prices. Therefore, an investor can easily trade or invest in any commodity with the help of these ETFs. They are highly volatile as the prices of commodities are affected by global factors.

Example: Kotak Silver ETF has physical silver as underlying asset; therefore, any change in the price of silver will affect the returns of this ETF.

4. International ETF

The ETFs which invest their funds in financial markets of foreign countries are known as International ETFs. They provide investors an opportunity to earn profit from the growing economies around the world.

Example: Motilal Oswal NASDAQ 100 ETF primarily invests in the companies listed on the NASDAQ exchange of the US, and provides an opportunity for an investor to gain exposure in the US market.

5. Thematic or Sectoral ETF

The ETFs which invest in a particular sector, such as the IT , financial, etc. or follow a particular theme, such as infrastructure, etc., are known as Sectoral or Thematic ETFs. These ETFs carry high risk and therefore, are suitable for investors seeking high returns.

Example: ICICI Prudential NIFTY IT ETF, as the name suggests, primarily invests in India’s IT companies.

6. Smart Beta ETFs

These ETFs follow certain strategies and invest in a particular market index, which carries low volatility, high momentum, etc. This ETF is ideal for investors who wish to invest in a particular strategy.

Example: ICICI Prudential Nifty 100 Low Vol 30 ETF, which invests in the top stocks of Nifty having low volatility. 

Read Also: Best ETFs in India to Invest

Advantages of Investing in ETFs

The significant advantages of investing in ETFs are as follows:

1. Low Cost: The expense ratios of ETFs are comparatively lower than actively managed funds, providing a cost-efficient investment option for investors.
2. Portfolio Diversification: One can diversify their portfolios by investing in ETFs, as they invest in a basket of stocks.
3. Transparency: ETFs generally disclose their holding daily, hence it provides clarity to investors about what they are holding in their portfolio.

Disadvantages of Investing in ETFs

The significant disadvantages of investing in ETFs are as follows:

1. Tracking Error: There are various reasons, such as fund expenses, timing of rebalancing the portfolio, etc., due to which an ETF may not be able to match the returns of the index in which it is investing accurately. This deviation in returns is known as tracking error.
2. Alpha: As ETFs are passively managed funds, they are not able to outperform the benchmark, which we can generally see in the case of an actively managed fund.
3. Market Risk: ETFs generally invest in a particular index, and their performance depends on how the underlying index has performed. Therefore, any downside movement in the underlying assets causes the losses. 

Read Also What is Gold ETF? Meaning & How to Invest Guide

Which ETF is Best for You?

Before choosing an ETF for investment, one should consider the following factors:

1. Investment objective: The investor’s investment objective plays an important role in deciding which ETF suits them. 
2. Risk Appetite: An investor should choose an ETF based on their risk profile. If an investor is conservative, they can opt for fixed income ETFs, whereas an aggressive investor can invest in Equity or Sectoral ETFs.
3. Tracking Error: It is one of the key factors which one should consider before choosing an ETF for investment. Lower the tracking error higher will be the returns.
4. Cost: Expense ratio plays an important role in choosing an ETF. An investor should choose the ETF with the lowest expense ratio in that particular category.

Cofnclusion 

On a concluding note, there are various types of ETFs available for investment, which can help an investor diversify their portfolio. An ETF offers high liquidity and allows an investor to invest in a variety of assets with limited capital. However, there are certain ETFs that carry high risk. Therefore, one must consider their risk profile and consult an investment advisor before making any investment decision.

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