Exchange-Traded Funds: Things to Know Before Investing

Going by numbers, equity ETFs have almost witnessed a  double rise from 66 to 131 between March 2020 and March 2023. 

Generally, an ETF is a  security that mirrors an index such as NSE Nifty or BSE Sensex, a commodity, bonds, or a basket of assets such as an index fund.

An investor who buys shares or units of an ETF is actually buying shares or units of a portfolio that mimics the yield and return of its native index. 

A core difference between ETFs and other such types of index funds is that ETFs do not aim to outperform their corresponding index, they merely mirror the performance of the Index and not look at beating the market.

As per their nature, ETFs can be suitably classified into different types: equity ETFs, fixed-income ETFs, commodity ETFs, and currency ETFs.

Before investing in ETFs, an investor needs to be aware of a few things. For instance, there can be a difference between the returns offered by an ETF scheme and the underlying index, which is the tracking error. So, a lower tracking error highlights that the ETF scheme returns are the same as the index. Ideally, opt for an ETF scheme with lower tracking errors.

Also,  considering ETFs are traded on the stock exchange, ETFs that have higher liquidity could have lower costs while those with lower liquidity could have higher costs. In addition, one needs to check the trading volumes of ETFs. 

When it comes to taxation, different ETF types tend to be taxed differently. Capital gains from a net asset value (NAV) rise are regarded as long-term capital gains (LTCGs) in case the equity ETFs are held for more than 12 months. 

As per the latest NSE figures, the assets under management (AUM) of passive funds in the country have surged to US $5 lakh crore, this includes ETFs that mirror the Nifty indices.

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