Exchange Traded Fund: Why you should invest in ETFs

Updated: June 14, 2021 12:07 PM

The stock market tends to be volatile owing to a variety of factors that affect market sentiments and can lead to sharp price movements.

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Equities offer investors the option to invest in stocks of companies that can potentially witness good growth. However, equity as an asset class is intrinsically volatile and there are testing periods where investors can face extreme volatility. The stock market tends to be volatile owing to a variety of factors that affect market sentiments and can lead to sharp price movements. For a retail investor, it might not be possible to stay updated on all those factors.

These sharp and often negative price movements can have an adverse impact on an investor’s equity investing experience. Without the requisite knowledge and experience, first-time investors can suffer large losses. Caught in a whirlpool of market volatility, lead by a negative investment experience, some of these investors would be scarred for life and may never return to equities, having lost faith in the asset class.

In order to mitigate such a negative experience, a prudent approach would be to use ETFs as a stepping stone into equity markets. Most ETFs are index funds, i.e. they hold the same securities as a stock market index and that too, in the same weightings. Since they replicate the index holdings, they generate returns similar to the underlying index. E.g. Nifty 50 Index ETF will hold all the stocks of Nifty 50 in the same proportion as the index. As a result, the fund will mirror the returns generated by the Nifty 50 index. Similarly, BSE 500 ETF will invest in the 500 companies and the investors too would get a chance to participate in them via investing in BSE 500 ETF. The NAVs of such schemes rise or fall in tandem with the rise or fall of the index.

Why ETFs?

ETFs are an excellent, convenient, one of the cheapest ways to take exposure to equities for investors who have long-term goals and want to invest in equity without taking too much risk. The diversity of an ETF makes it less volatile than an individual stock. More importantly, during volatile times, the draw-downs seen in an index fund are likely to be less sharp, unlike direct investing. By investing in ETFs, one can get market-linked returns without the additional stress of security selection or market timing. Also, ETFs are listed on the stock exchanges and can be traded (bought or sold) at any time during the market hours via a demat account.

By investing through ETFs, investors can tap into equities in a diversified manner and better risk-adjusted returns eliminating any form of emotional bias and stock-specific risks, which are pitfalls of direct investing.

For the last year, investors in India have been warming up to the concept of ETF. The same has been reflected in the number of folios for equity ETF schemes. There has been an unprecedented growth in terms of ETF folio count, with the number of folios more than doubling from 19 lakhs to 42.5 lakhs, over the last year, and correspondingly the AAUM increased from 1.5 lakh crores to 2.8 lakh crores.

Diversity in Offerings

Within the ETF universe itself, there are a variety of offerings available. There are ETFs that are market capitalisation based such as the Nifty ETF, Sensex ETF, Midcap ETF, BSE 500 ETF, etc. Other than this, there are ETFs based on specific sectors such as IT, banks, healthcare, etc. This means if an investor is bullish on a sector, say IT sector, and wants to take exposure to a bunch of names from the IT space, then investing in an IT ETF is a possibility.

Other than these plain vanilla offerings, for a savvy investor, there are factor-based ETFs available as well. Currently, most of the schemes are based on factors namely – alpha, low volatility, momentum, value, and quality. These could be single-factor funds or a combination of these factors. To conclude, if you are an investor looking to invest in equity markets then ETFs can prove to an interesting stepping stone.

by Nitin Kabadi, Head- ETF Business, ICICI Prudential AMC

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