Exchange-traded funds, or ETFs for short, are a type of security that trades on the stock market much like stocks. The money invested in exchange traded funds (ETFs) is pooled from many investors and used to buy stocks, bonds, and other debt and equity instruments, as well as derivatives. The Securities and Exchange Board of India regulates most exchange-traded funds (SEBI).
How do they work?
Exchange-traded funds, or ETFs, combine the best aspects of stocks and mutual funds. Most of the time, they are made with creation blocks and then traded as individual shares on the stock exchange. Exchange-traded funds (ETFs) can be purchased and sold throughout the day, every day, during equity trading hours on all of the world’s major stock exchanges.
The value of an ETF’s shares will fluctuate as the market prices the underlying assets in the fund’s portfolio. An ETF’s share price moves up or down in relation to the underlying asset or assets, respectively.
Dividends paid out to ETF shareholders are tied to the success of the ETF’s underlying investments and the quality of management at that firm.
Actively managed ETFs are those that are run by a portfolio manager who, after looking at how the stock market is doing right now, takes calculated risks by buying shares in good companies. While actively managed ETFs may invest in a wide variety of companies, passively managed ETFs typically only put money into stocks that are part of a particular market index that is trending upwards.
Types of an ETF
Bond ETFs
Bond exchange-traded funds (ETFs) are utilised to give investors a steady stream of income. The distribution of their income is tied to the value of the bonds underlying them. Government bonds, corporate bonds, and municipal bonds (issued by states and municipalities) are all possible examples. Bond ETFs are not subject to expiration like the bonds they track. In most cases, the buying or selling price differs from the bond’s face value.
Equity ETFs
Stock (equity) exchange-traded funds are a type of ETF that holds a collection of equities that together track a specific market segment. A stock ETF could, for instance, follow the performance of the automotive industry or international stock markets. The goal is to spread risk across an entire industry by including both well-known companies and new ones with great potential. Stock ETFs are a good alternative to stock mutual funds because they have lower fees and don’t require you to own actual securities.
Industry ETFs
Industry Exchange-Traded Funds (ETFs) are investments that track a single market segment. For example, an energy sector ETF would buy shares in companies in the energy industry. When you buy an exchange-traded fund (ETF) that focuses on a certain industry, you want to gain exposure to the potential gains in that industry.
The IT industry is one area that has benefited from investment in recent times. Also, because ETFs don’t involve owning stocks directly, the risk of a drop in value due to stock volatility is lessened. To take advantage of market fluctuations, investors can use industry ETFs to switch between different industries.
Commodity ETFs
Commodity exchange-traded funds (ETFs) are funds that invest in commodities like crude oil and gold. There are a number of advantages to using commodity exchange traded funds. First, they increase the portfolio’s diversity, which facilitates the use of hedging strategies.
When the stock market is down, commodity exchange-traded funds (ETFs) might be a safe haven. Second, compared to owning the actual commodity, buying shares in an exchange-traded fund that specialises in commodities is more cost-effective. This is because insurance and storage fees are unnecessary for the former.
Currency ETF
Exchange-traded funds (ETFs) that focus on currencies are a type of mutual fund that tracks the value of currency pairs. Currency exchange traded funds (ETFs) can be used for a variety of scenarios. They can be used to make predictions about the future value of a country’s currency in light of changes in that country’s government and economy. Importers and exporters also use them to diversify their portfolios or to protect themselves from the risk that foreign exchange rates will change. The risk of inflation can be offset by using some of them as a hedge. Bitcoin is now available as an exchange-traded fund.
Inverse ETF
Gains can be made by shorting stocks in an inverse ETF in the hopes of profiting from a decrease in stock prices. Selling a stock short means you anticipate its price will fall and plan to buy it back at a cheaper price. An inverse ETF will use derivatives to short a stock. To put it simply, they are wagers on the expectation that the market will fall.
The value of an inverse ETF rises when the market falls.
Leveraged ETF
Leveraged exchange-traded funds aim to provide investors with returns that are two or three times those of the underlying investments. A 2% leveraged S&P 500 ETF, for example, would gain 2% if the index rose by 1% (and lose 2% if the index fell by 1%). Financial derivatives like options and futures contracts are used to increase the potential profit from these goods. There are also leveraged inverse ETFs that try to make returns multiply in the opposite direction.
How to invest in an ETF
Exchange-traded funds are traded on the stock market much like common stocks. Because there are both buyers and sellers in the market, the price of ETFs fluctuates throughout the day. The price of these products can be based on the NAV of the assets that they represent. Since each ETF has its own individual ISIN number, you can keep ETF units in a demat account.
Depending on market conditions, you can buy ETF units by placing a direct order on the stock exchange via the AMC’s terminal. The units will be added to your account on the clearing day for the type of ETF you bought.
If you place an order to purchase 10 units of an equity ETF at INR 5,000, the price of your purchase may rise or fall throughout the day based on the ebb and flow of the underlying equities. You should expect the units to be deposited into your demat account on day T+3.
You can sell your equity ETF units just like you would sell regular stock shares by placing a sell order on your trading platform.