InvestorQ : Do ETFs only track indices or do ETFs track other asset classes too?
Swati Naik made post

Do ETFs only track indices or do ETFs track other asset classes too?

user profile image
Bhavika Nehru answered.
1 year ago

While ETFs are principally for index tracking, you can have an ETF on any conceivable asset under the sun. There are ETFs on indices, on gold, on silver, on debt market indices, on money market indices etc. In fact, there are also inverse ETFs or reverse ETFS, where the ETF gains if the Nifty goes down and the ETF loses if Nifty goes up. This is just like short selling the index through an ETF.

The logic behind ETFs is index tracking. It is believed that over the long term, it is hard to consistently beat the market. Hence, by buying index fund or an ETF, you get rid of most of the company specific and industry specific risks. The Index tracking has been widely acclaimed in practice and in theory as a winning strategy for long term investing. It has been the experience that globally, a majority of actively managed funds have under-performed their respective benchmarks over a long period of time. Of course, in India many funds still manage to outperform the index but that is for a different reason which we shall not get into here.

William Sharpe, a Nobel laureate in Economics, believes that all active fund managers together can never outperform the market. Consequently, all classes of investors viz. institutional and retail are increasingly moving towards investing in well-defined indices, which are professionally managed. In fact the largest mutual fund scheme today is an index fund on the S&P 500 managed by Vanguard in the US. ETFs are based on two very interesting premises. Firstly, it is hard for any fund to consistently beat the index and the focus is on the word consistently. Secondly, from a more pragmatic standpoint, it is very difficult for investors to identify such funds that can outperform the market. In case of index ETFs, the problem of choice is much lesser.