FAQ'S on Exchange Traded Funds (ETF)
What are Exchange Traded Funds?
Exchange Traded Fund is a security that tracks an index, a commodity or a sector like an index fund or a sectoral fund but trades like a stock on an exchange. It is similar to a close-ended mutual fund listed on stock exchanges. ETF's experience price changes throughout the day as they are bought and sold.
What types of ETF's can be traded in BSE?
Currently there are three types of ETF's which can be traded in BSE. These are:
What are Equity ETF’s?
- Equity ETF's.
- Gold ETF's.
- Liquid ETF's.
Equity ETF is a basket of stocks that reflects the composition of
an Index, like S&P BSE SENSEX. The ETFs trading
value is based on the net asset value of the underlying stocks that
it represents. Think of it as a Mutual Fund that you can buy and sell
in real-time at a price that change throughout the day. Currently
there are eleven equity ETF's which can be traded in BSE.
What are Gold ETF’s?
Gold ETF is a special type of Exchange traded fund that tracks the price of gold.
What are Liquid ETF’s?
Liquid ETF's are the money market ETF's, the investment objective of which is to provide money market returns. Liquid BeES launched by benchmark mutual fund is the first money market ETF in the world. Liquid BeES will invest in a basket of call money, short-term government securities and money market instruments of short and medium maturities.
How does one trade ETF’s?
ETF's can be bought / sold just like stocks through trading terminals anywhere across the country.
Difference between an Exchange Traded Fund & Mutual Funds (Close Ended Fund and Open Ended Fund)?
Difference between ETFs and Futures?
||Stock Market / Fund itself
||At NAV plus load, if any
||Significant Premium / Discount to NAV
||Very close to actual NAV of Scheme
||Through Exchange where listed
||Through Exchange where listed / Fund itself.
||Equitising Cash, Hedging, Arbitrage
||Possible at low cost
Though ETFs and Futures provide an exposure to the same underlying index, the differences between them are:
What happens in case of default on payment or delivery of ETF's?
- ETFs trade in much smaller investment sizes than a futures contract making it possible for retail investors to participate in index investing.
- Futures trading require an account with a broker having derivatives terminal and are subject to margin requirements prescribed by the exchanges.
- Futures involve significant leverage which magnifies losses in the vent of prices moving against the positions held by the investor.
- Futures contracts must be rolled-over every three months (or every one month if liquidity is poor in far month contracts) which can lead to higher trading costs and tracking error.
As clearing and settlement is done through the exchange, the exchange's clearing house guarantees all trades. Any shortfall in units will be auctioned by the exchange and the investor is protected by the exchange mechanism.
Can ETF units be used for paying margins to the Stock Exchange?
What are the applications of ETFs?
- Liquid BeES ETF units can be deposited by the members with the exchange towards collateral requirements (liquid assets) for margin purposes. These units will be considered as cash equivalent.
- Other ETF units can also be deposited towards collateral requirements. However these units will be considered as non-cash equivalent.
- Investors can use ETFs for Strategic Asset allocation (core holdings) and tactical asset allocation to reflect their short-term investment insights.
- Investors can use ETFs to make sector bets or reduce their sector exposure.
- Investors can effectively short or hedge Index exposure by selling ETFs against long stock holdings thereby reducing the broad market risk exposure or beta of the portfolio.
- An investor in an open-ended mutual fund can only purchase or sell at the end of the day at the mutual fund's closing price. This makes stop-loss orders much less useful for mutual funds, and not all brokers even allow them. An ETF is continually priced throughout the day and therefore is not subject to this disadvantage, allowing the user to react to adverse or beneficial market condition on an intraday basis.