ETFs vs Index Funds

1. ETFs vs Index Funds ETFs vs Index Funds Ghazal Jain – Associate Fund Manager, Alternative Investments 24th Sept 2021

2. Active Investing & Passive Investing Active Investing Passive Investing • Aim to beat the market’s returns • Aim to track the market’s performance • Active selection of securities, thus higher expense ratio • No active decision in choosing securities , thus lower expense ratio • Involves buying and selling of individual securities or actively managed mutual funds • Involves buying and holding Index funds and/or ETFs

3. 3 What are ETFs? • ETFs = Exchange Traded Funds • ETFs are passive instruments that closely track an index Graph is for indicative purpose only

4. 4 How do ETFs work? • An ETF is a basket of securities (stocks/bonds/gold) , units of which are sold on an exchange • Investors can buy units of that basket, just like buying shares of a company • Like mutual funds, ETF units represent partial ownership of underlying basket of securities • Your investment in the ETF could increase or decrease in value as the price of the underlying stocks/bonds/gold changes • Like individual stocks, buyers and sellers trade the ETF units throughout the day at prices that change based on supply and demand

5. The most common types of ETFs in India are: Equity ETFs track a particular index of stocks. The index may be based on the companies’ size, region, industry Bond or Fixed Income ETFs track a portfolio of corporate and/or government bonds Gold ETFs track the price of gold

6. Equity ETFs Equity ETFs track a particular index of stocks. • They aim to track the price of the index and mimic its returns • Stock A Stock B Stock C CASH 50 stocks of Nifty Index NIFTY ETF ETF UNITS Graph is for indicative purpose only

7. Benefits of Equity ETFs Better Diversification Lower costs than Actively managed Mutual Funds* Tax efficiency Flexible trading *Being passive products, they tend to have lower expense ratios than actively managed mutual funds

8. Gold ETFs Gold ETFs are Investment vehicles that invest in physical gold • They aim to track the price of gold and generate returns in line with the returns of physical gold • CASH GOLD ETF ETF UNITS Graph is for indicative purpose only

9. Features of Gold ETFs • Gold ETFs, even though a financial form, are very real as each and every ETF unit is backed by 24 carat physical gold • Buying Gold ETFs means you are purchasing gold in an electronic form. When you actually redeem Gold ETF, you don’t get physical gold, but receive the cash equivalent • Just as shares represent the extent of equity ownership in a company, units represent your extent of ownership in the ETF’s underlying asset i.e. gold • Gold ETF units are listed and traded on NSE and BSE. You can buy and sell gold ETFs using a DEMAT account just as you would trade in stocks • Gold ETFs combine the flexibility of stock investment and the simplicity of gold investments

10. Benefits of Gold ETFs • Each and every ETF unit is backed by 24 carat physical gold • Stored in accredited professional vaults: Investors do not have to worry about purity, storage, and insurance of gold Purity • No making charges or high premiums • Gold ETFs transfer benefit of wholesale purchase prices to investors • Benefit of GST credit at Scheme level time of selling gold • Traded close to the market price of physical gold, with thin difference between buying & selling price Price efficiency Liquidity • ETF units can be continuously bought and sold on the NSE and BSE • They offer investors a means of participating in the gold market at low denominations of 1/2 gm Accessibility • You can purchase and sell online with a DEMAT account from the comfort of your home Convenience Regulation • Gold ETFs are regulated by SEBI

11. 11 Costs of an ETF Explicit Costs • Expense ratio • Brokerage commissions Implicit Costs • Tracking error • Bid-ask spreads

12. 12 What are Index Funds? Passive mutual funds that copy performance of an index like Sensex or Nifty Hold same securities as index in same proportions Buys or sells securities only when composition of Index changes

13. Benefits of Index funds Better Diversification Lower costs Tax efficiency

14. 14 ETFs vs Index Funds ETFs Index Funds Investment Offers exposure to assets of a benchmark index Offers exposure to assets of a benchmark index Management Buy/Sell Passively managed Can be bought or sold at real time NAV Passively managed Can be bought or sold only at the end of the day at NAV Liquidity Buy and sell on exchange Buy and sell with AMC only Performance Similar to or lower than the benchmark index Similar to or lower than the benchmark index Costs Expense ratio (0.1-0.5%) + Brokerage commissions Expense ratio (0.5-1.5%) DEMAT account Required Not required SIP facility No Yes

15. 15 Limitations of ETFs and Index funds 1) They don’t offer flexibility to the fund manager in managing market downsides 2) They simply mimic an underlying benchmark and hence cannot generate alpha 3) Index funds lag their benchmark returns due to the presence of tracking error

16. 16 Which passive investment should you opt for? • While choosing between an ETF and index fund, investors need to weigh the pros and cons of both the passive avenues • Broadly, if you are seeking convenience, index funds are likely to be the right choice • But if you want cost advantage and want to time your entry and exit based on your analysis of the markets, ETFs are likely to be the better alternative • For both ETFs and Index funds, you should pick a fund with minimum tracking error

17. The choice should not be Active or Passive, it should be Active AND Passive • Large cap space: efficient and widely covered = ETFs and Index Funds • Mid /small caps, Value style, ESG investing = Scope for active management

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