What are ETF? Should you invest?

By Super

Updated: Tuesday, April 30, 2013, 18:11 [IST]

Exchange Traded Fund (ETF) is an investment fund or a basket of securities, like stock it is traded on a recognised stock exchange on real-time basis. While the instrument is a mutual fund it is traded like hybrid, thus, it is more like a hybrid. Their units can be bought and sold directly on the exchange, through a stockbroker during the trading hours.

ETFs provide investors the opportunity to buy or sell an entire portfolio of stocks in a single security, as simple as buying or selling a shares; underlying securities can be stocks, commodities or bonds.

ETFs can be either close-ended or open-ended and since they are exchange traded, there is minimal interaction between investors and the fund house.

In India, ETFs invest in stocks of Indian companies, precious metals and currencies. They are listed across the various stock exchanges of India, where they capture the major sectors of the Indian economy.

Some of the actively traded ETFs in India are WisdomTree India Earnings Fund, iPath MSCI India ETN, Market Vectors India Small Cap Index ETF, etc.

How does an ETF work?
Unlike regular mutual fund, one cannot buy and sell ETF from the the fund house. Asset Management Company (AMC) have appointed some authorized participants, who first deposit all the underlying securities (shares, bonds, commodities such as gold, etc.) with the AMC and receive 'creation units' in return from AMC.

These creation units are large block which are further split into small units and accordingly bought or sold in the open market on the recognised stock exchange by these authorized participants. Since the creation units are comprised of a large number of units, so only wealthy investors can deal directly with the AMC.

Retail investors can buy and sell over the recognised stock exchange by opening an account with any brokerage house.

How does the price of ETF is determined?
Given that an ETF is traded on the stock exchange, its price may not necessarily be the same as the NAV of the underlying portfolio. Instead, the market price of an ETF is determined by forces of supply and demand for the ETF shares. The value of ETFs largely depend on the supply and demand of the underlying securities, though there are many other factors too which affect their market price.

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