| Exchange Traded Funds - Will they take off ? |
Exchange Traded Funds, ever heard of this? A baby of financial innovations, you may say, it is. Yes, this is the new kid on the block. And, your date with it, perhaps the most innovative investment avenue in recent times, is not far away, given the upheaval in the stock market which has shaken many fund managers (Remember all high flying tech stocks have been grounded by the recent tech wreck across the globe) and who are desperately looking for new ideas to stay afloat.
The concept of Exchange Traded Funds (ETF) is similar to that of the Mutual Funds. This is in the sense, that it represents a basket of stocks that can be bought or sold in a group. Each share of an ETF, like a mutual fund, represents a portfolio of stocks and their resulting composite value. A closer look shows that the ETFs actually function more like stocks rather than mutual funds. An ETF can be sold short, bought on margin or purchased through limit orders. Many ETFs also offer options. In other words, an investor can trade an ETF just the way a stock is traded.
The ETFs have a combined advantage of the closed and the open-ended funds, while they bypass some of their inherent disadvantages. Mutual Funds can only transact business at the end of the day, and are deprived of the volatility in the stock market. However, ETFs unlike stocks can be bought and sold at any point of time. In an open ended fund the burden of the sales load is borne by the investor. This is not the case with the ETFs, they do not have any sales load. Another advantage is that, in mutual funds when an investor redeems his shares, the fund manager is forced to offload a part of his portfolio in the market leading to transaction costs and capital gain taxes. But in the case of ETFs, the units are exchanged for a basket of stocks therefore there are no taxes or capital gains involved.
Though the ETFs hold good over the mutual funds, it has some disadvantages too. The concept of Mutual fund is for the people who buy and hold, so the ETFs would not stand good for such people. Though there is no sales load for the ETFs, one has to go through a broker, paying him a heavy brokerage. The ETFs do not trade at the NAV of their underlying holdings, instead the market price of the ETF is determined by the demand and supply for the share. The question which arises here is, how would the ETFs react in face of any massive market correction? Food for thought?
The US experiences suggest that despite all its charm over the mutual funds, ETFs have not gained much favour from the investors there. And the investors still prefer actively managed mutual funds to ETFs. Whether the Indian investors would embrace this new baby or not, would be interesting to watch.
A Sheeba
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