Factors to consider for ETF Investments

  • Posted By : reliancesmartmoney.com
  • Tuesday Apr 23, 2019

Some important factors that investors should look at while investing in ETFs are collated for your reference.

You can go through these to be able to make a smart choice for yourself.

  • Liquidity: Liquidity of an ETF makes it easy for investors to buy or sell on the stock exchange. This implies that there should be enough trading volumes of the ETF on the exchanges during the day. Generally, ETFs with a larger investor base have higher liquidity on the exchange.
  • Lower tracking error: Tracking Error is the difference between an ETF and its benchmark. Closer the returns of an ETF to that of the benchmark index, lower is the tracking error. Low tracking error is an important factor that the Investors should look at over long periods of the scheme's existence.
  • Soft impact cost: Soft impact cost is an indirect cost of executing a transaction on an exchange. Higher the liquidity, lower the impact cost and therefore lesser the indirect cost to investors. When such orders are executed, chances are that the underlying security will fluctuate and, hence, increase the purchase costs. One needs to watch out for this cost.
  • Low expense ratio: Annual charges of an ETF are shown in its expense ratios which include, fund expenses, including: management fees, administrative fees, operating costs; and all other asset-based costs incurred. One should not see expense ratios in isolation, but also see liquidity and historical track record. (One basis point is one-hundredth of a percentage point.)
    Because of the passive nature of the fund, and their structure that closely follows an index, most ETFs have lower costs than other equity funds.
  • Benchmark: To choose and ETF, you should first decide on the market, market segment, or industry sector you wish to track, and then decide on the appropriate index for that market. Construction methodology is different for every index provider which results in wide variations in turnover and other portfolio characteristics. Benchmarks that track the same market segment can deliver very different results.

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A few Comparisons for ETFs and other investment options to help you make the investment of your choice:

ETF v/s Mutual Funds

ETF

MUTUAL FUNDS

ETFs are passive by design

Mutual Funds investments may be either actively or passively managed

Passive ETF mutual funds are designed to mimic an index focusing on equities or commodities of a basket of an asset class

In actively managed funds, a team of fund managers select securities with the intention of outperforming the index

In an efficient market, where it is difficult to outperform the index, fund managers often suggest investing in passive funds

Active funds are popular for exceeding in the general market and thus show higher growth potential

ETFs that do not track indexes publish their full portfolios on a daily basis, providing ongoing portfolio transparency

Actively managed mutual funds publish their portfolios only after a lengthy time lag, as transparency is actually likely to be detrimental to their business prospects

 

ETF v/s Index Funds

 

EXCHANGE TRADED FUND (ETF)

INDEX FUNDS

Pricing and Trading

ETF prices are 'Live' / 'Realtime' on the stock exchange and can be traded like individual stocks

The Net Asset Value (NAV) is determined at the end of the trading day

Transaction Cost/Fees

ETF's have low expense ratio and transaction costs are similar to an individual stock traded on the exchange

There are few transaction costs and the index fund charge Management expenses on the fund

Tracking Error

ETF's don't have to keep funds aside for liquidity, hence they are able to track an index more closely

Index fund managers have to keep certain percentage of funds aside to ensure liquidity to buyers and sellers. Hence, they are less effective in tracking an index

Portfolio Disclosure

ETF's disclose their holdings on a daily basis

Index funds disclose their holdings on a periodic basis

 

Gold ETF v/s Physical Gold

 

GOLD ETF

PHYSICAL GOLD

Quantity to buy/sell

Available in small quantities, hence are more affordable

Available in standard denomination, which requires large investments

Mode of storage

Available in dematerialised form, they can be stored electronically. Hence, they also eliminate the risk of theft

Normally available in bars they need to be stored in lockers or safety vaults

Convenience

They are held electronically hence physical handling is eliminated

In buying and selling they need to be moved physically from one place to another

Pricing

Pricing is done as per international standards and is always transparent

Prices are never uniform, and differ from one jeweler to other

Purity

Fund house ensures the quality of the same

Always comes with a question of purity in mind

Charges

Have ETF management fee as well as brokerage charges associated with each transaction

Other than the charges for delivery, no other charges are involved in case of physical gold

 


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