Variety for All – Types of Exchange Traded Funds (ETFs) in India

ETFs are an increasingly popular investment route among retail investors in India. There has been a multi-fold rise in retail folio count of Exchange Traded Funds (ETFs). While there are multiple ETF types, ETFs can be categorized into three major asset classes – equities, debt and commodities.

Equity ETFs

ETFs are passive investment products that track market indices by investing in securities in the same proportion as the underlying index. Further, these products combine the benefits of diversification within equity, simplicity of a mutual fund, and liquidity of stocks.

Exchange Traded Funds can also be classified into additional categories:

• Market Capitalization based: These ETFs track different market cap indices. For example, an ETF that tracks NIFTY 50 Total Return Index (TRI), will measure the performance of the top 50 companies that constitute the NIFTY 50 index.
• Smart Beta: These ETFs pre-constructed smart beta indices. Popular smart beta ETFs provide exposure to Low Volatility, Momentum factors. Smart Beta ETFs offer a differentiated investing strategy by adopting different styles within equities, using passive approaches by tracking a pre-constructed alternate index.
• Sectoral or Thematic: These ETFs track an underlying index that invests in a basket of securities from specific sectors. For example, an ETF that tracks the NIFTY Bank TRI, will measure the performance of the most liquid and large Indian Banking stocks.
• ESG: These are ETFs tracking indices that are constructed based on parameters surrounding environmental, social and governance characteristics. These funds offer a simple way to diversify investments across a wide range of companies that rank high on these characteristics.

Debt ETFs

Debt ETFs track debt indices allowing investors to take exposure to various types of fixed income securities including Government securities, T-bills, corporate bonds, etc. The National Stock Exchange (NSE) has divided fixed income indices into four broad categories – Target Maturity, Duration-based, Money Market and Maturity-based.

Currently in India, debt ETFs are still evolving, with majority being invested by institutional investors. But over the past few years, this trend has shifted, and retail investors too are investing in this ETF category. The probable reason behind this shift is that as an asset class, debt provides stability to an investor’s portfolio. In that light, debt ETFs could make a good low cost addition to an investor’s portfolio.

Commodity ETFs

These Exchange Traded Funds invest in physical goods such as agricultural commodities, precious metals and natural resources. The idea behind the investment in commodities is to take exposure into this asset class and gain overall portfolio diversification. For example, the two types of commodity ETFs in India are Gold ETF and the recently introduced Silver ETF. Both Gold and Silver ETFs invest in the respective commodities and their related instruments in order to generate returns that are in line with the prices of the underlying commodities (subject to tracking error).

Conclusion

Diversification offers a better risk-adjusted performance. For building diversified portfolios, ETF investing provides a low-cost access for investing in a basket of securities across three different asset classes.

The information contained in this document is for general purposes only and not an investment advice. Readers should seek professional advice before taking any investment related decisions.

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