ETFs are gradually starting to shake up the asset management sector. They have an advantage over other investment vehicles because they are low-cost passive index funds that can be traded on the capital market segment like stocks. Given their high liquidity, low costs, easy trading, and great diversification benefits, it is not surprising that ETFs have become more and more popular. From INR 1.54 lakh crore at the beginning of FY21 to INR 2.9 lakh crore at the end of FY21’s, ETF trade in India has nearly doubled in the matter of one year.

According to Bloomberg data, 50 new ETF funds were introduced by February of 2022, up from 38 at the same time in the previous year. ETF assets are currently valued in India at over Rs 4 lakh crore, and this figure is quickly increasing.

The fact that ETFs are offered for a variety of asset classes, like equity, fixed income, commodities, and sectoral funds, may be one crucial factor in their widespread acceptance. Here is a list of ETF types you could consider:

Equity ETF tracks equity indices, or stock indices of a specific industry.

Liquid ETFs invest in money market instruments, which are typically low-risk, high-liquidity investments with short maturities and low expected returns.

Commodity ETFs are passively managed investments that follow an index of the commodity markets, such as the price of gold or silver.

Bond ETFs provide the versatility of stock market investing with the advantages of debt investment at a lower expense ratio than MFs.

ETF Fund of Funds (FoFs) invest in ETFs from various asset management firms while tracking other mutual funds. These might include a mix of the aforementioned options, such as equity, liquid, commodity, etc. funds.

ETFs offer a great deal of trading flexibility. As opposed to mutual funds, ETFs are traded continuously throughout the day on stock exchanges, but MFs are only traded once a day at the conclusion of the stock market.

Things to Consider in 2022 Before Investing in ETFs

Assets Under Management (AUM)

The size of the fund, or its AUM, is a good indication of its market acceptability and will therefore provide more liquidity at relatively lower costs. The outstanding shares are multiplied by the market price (NAV) gives you its AUM. The difference between an ETF’s market capitalization and the underlying security’s NAV (Net Asset Value) is typically what determines the value of the ETF. Larger the AUM, higher the liquidity.

Underlying Assets
The underlying asset or instrument is what gives an ETF its value, just like with any investment. Therefore, choosing the market that one wants to invest in would be the first step. The next decision is whether you want to invest in a benchmark index or go by a thematic or sectoral approach. It is always advisable to choose an index that is widely followed and provides a good mix of options in order to ensure risk diversification.

ETFs provide much better liquidity than MFs because they are traded all day long. The ETF’s trading volume demonstrates the level of interest in it. Therefore, it will be more challenging to sell ETFs with low liquidity, and vice versa. When trading, it’s important to recognize the trend, and before making an investment, any trend decline needs to be carefully examined.

Total Expense Ratio
To manage an ETF fund, managers charge an expense ratio calculated as a proportion of the total investment. A high expense ratio raises the cost of the portfolio and should be included in one’s calculations. The expense ratio’s value is set by fund houses. Therefore, when choosing between funds of similar quality and underlying assets, the expense ratio may be a useful tie-breaker.

Tracking Error
Fund managers frequently invest in some but not all of the securities listed in an index or fund while simulating it. This might result in a tracking error, which is a difference in returns between the underlying index and the specific ETF. It illustrates how closely the ETF follows the underlying index. It makes sense to choose ETFs with little tracking error.

In order to effectively allocate assets in accordance with their financial goals, risk appetite, and time horizon, ETFs give investors exposure to a wide segment of the equity, commodities, fixed income instruments, and money markets. A multitude of tactical, theme-based, long- and short-term investment strategies are easily possible with different ETFs as building blocks, which is another advantage of ETFs.

Would you be interested in learning about ETF-compatible strategies?