The multiple benefits offered by an ETF – ranging from liquidity and flexibility to diversification and transparency – make it a valuable addition to your investment portfolio
By Ashwin Patni
When it comes to investing, your returns are as good as the portfolio you construct and to get the portfolio right you have to get the asset— equity, debt, and commodity —allocation aligned with your objectives. For this, you need to spend sufficient time to identify and analyse each asset class and then determine the level of allocation.
Once the target asset allocation is decided, you need to identify the investments within each. Several macro and micro factors affect the market sentiments, leading to sharp variation in performance. And staying up to date on all these factors, consistently, is not easy.
In such cases, a passive investment instrument like the Exchange Traded Fund (ETF) can be an ideal solution. Simply put, an ETF is a pooled investment fund that tracks and replicates an index—which can invest in different asset classes such as equity, debt and gold.
Typically, any ETF takes the entire list of securities in the index, which may include stocks, bonds, commodities, and currencies, and develops a basket of them in the same proportion as the index. Each basket has its own ticker. You can purchase a share of that basket, just as you would buy a company’s stock. More importantly, ETF shares can be bought and sold anytime during market hours. Hence its price fluctuates depending on the net asset value of the underlying basket of securities that it represents.
This is the key differentiation that ETFs offer. It gives you the diversification benefits of mutual funds while replicating the simplicity with which equities can be exchanged. If you are looking for a long-term buying and holding strategy, then ETF would be an option worth considering. Given the convenience, diversification and cost-effectiveness that ETFs offer, this category has started seeing increasing interest from both new-age as well as experienced investors.
Here are six aspects that make ETFs an important addition to your portfolio:
Easy diversification: Using ETFs, you can get exposure to multiple asset classes, like equities, bonds and gold. Each asset class behaves differently and has little to no co-relation in its performance. This helps you tide over volatility in a single asset class and protects returns.
Wider spread: In an ETF, any investment you make is distributed among a wide set of securities that are a part of the underlying index. For example, if you invest `500 in an ETF, your money will get distributed within all stocks in the index. This is advantageous compared to equities, wherein you need to buy a whole share of a single company.
Provide liquidity: ETFs trade daily on the exchange and do not have a lock-in period. This provides you with the benefit of liquidity, which means you can exit your investments easily whenever the need arises.
Cost-effective: ETFs have lower management fees since they are not actively managed funds.
Trading flexibility: ETFs provide trading flexibility. In other words, daily trading, as well as intraday trading, is possible with these funds during market hours. This provides you an opportunity to better utilise trading opportunities that arise in the course of the day.
Greater transparency: ETFs replicate the benchmark index, and the constituents are transparently available to you at all times. Also the passive approach helps your investment provide returns that are in tandem with the benchmark index’s returns.
To sum up, the multi-pronged benefits offered by an ETF—ranging from liquidity and flexibility to diversification and transparency—make it a valuable addition to your portfolio. Based on your financial goals and investment needs, you can choose to allocate a portion of your portfolio to an ETF.
The writer is head, Products & Alternatives, Axis AMC