InvestorQ : What exactly are exchange traded funds or ETFs and what is so special about them?
Swati Naik made post

What exactly are exchange traded funds or ETFs and what is so special about them?

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Bhavika Nehru answered.
1 year ago

You must have seen the mention of ETFs frequently in the newspapers and the business channels. Have you wondered what these ETFs are? Actually, these ETFs are just what their name implies: baskets of securities that are traded, like individual stocks, on an exchange. Unlike regular open-end mutual funds, ETFs can be bought and sold throughout the trading day like any stock. There is nothing like going to the AMC and buying or redeeming of ETFs and that is how they differ from traditional mutual funds.

One of the striking features of ETFs is that they are passive investment vehicles and this enables them to keep costs low. Most ETFs charge lower annual expenses than even index mutual funds. However, as with stocks, one must pay a brokerage to buy and sell ETF units, which can be a significant drawback for those who trade frequently or invest regular sums of money. ETFs can be bought and sold through your trading account opened with your broker and like in the case of shares you get delivery on the T+2 day into your demat account. These ETFs can also be sold in the stock market like any other shares.

Exchange traded funds (ETFs) first came into existence in the USA in 1993. It took several years for them to attract public interest. But once they did, the volumes took off with a vengeance. Over the last few years trillions of dollars have been invested in ETFs. About 60% of trading volumes on the American Stock Exchange are from ETFs. The most popular ETFs are QQQs (Cubes) based on the Nasdaq-100 Index, SPDRs (Spiders) based on the S&P 500 Index, iSHARES based on MSCI Indices and TRAHK (Tracks) based on the Hang Seng Index. The average daily trading volume in QQQ is around 89 million shares. In India we have ETFs on the Nifty, Sensex, gold etc.

Their passive nature is a necessity: the funds rely on an arbitrage mechanism to keep the prices at which they trade roughly in line with the net asset values of their underlying portfolios. For the mechanism to work, potential arbitragers need to have full, timely knowledge of a fund's holdings. ETFs are yet to pick up in a big way in India.