How ETFs came into being?
In recent years, ETFs, other than gold ETFs, also saw investors’ interest that has been gaining traction due to their low-cost structures & innovative themes.
Before starting, let’s take a quick glance at some figures! In India, between March 2021 and December 2021, the total assets under management (AUM) of ETFs rose nearly 40 per cent in India to Rs 4,02,601 crore. The market reports inform that with 122 ETFs in December 2021, there has been a rise of more than 18 per cent in the total number of ETFs during this period.
In recent years, ETFs, other than gold ETFs, also saw investors’ interest that has been gaining traction due to their low-cost structures & innovative themes.
Overwhelming, isn’t it?
What are ETFs, how did they come into being, why are they sought after by the investors worldwide, should you invest in them, what are smart beta ETFs, and what are the top-performing ETFs; all such queries would be answered below.
Around the 1970s, notable economists, academics & scholars made a keen observation that the majority of active investment managers or portfolio managers often fail to outperform the broader frontline indices. Hence, it was concluded that an average investor could earn adequate returns and compound money over the long term by holding a diversified portfolio of stocks in a similar proportion to the index. In a nutshell, it can be called as passive index investing.
However, the hiccup was that for an individual investor to execute such a strategy is a laborious and expensive task.
On December 31, 1975, mutual fund legend John Bogle launched ‘First Index Investment Trust’, the first public index mutual fund, which tracked S&P 500 index. The fund commenced operations with USD 11 million. At present, it is known as Vanguard S&P 500 Index Fund that manages assets worth USD 841.7 billion.
John Bogle’s endeavour was a proof of concept, which stood as a testament to the fact that investors possessed an abundant appetite for index funds. The passive investing style started gaining prominence and spread like wildfire. Several institutions floated index mutual funds, tracking a multitude of indices.
An exchange-traded fund (ETF) is an investment instrument that tracks a particular index, a commodity, or a mixture of diverse securities. Unlike mutual funds, they trade on stock exchanges with constant fluctuations in prices and can be effortlessly bought or sold like any regular stock during trading hours. They are low priced, liquid, charge minimal fees, have no exit load and there is no requirement of a minimum investment amount, an investor can even purchase one unit.
The beauty of ETFs is that, unlike stocks, diversification is possible through the purchase of a single ETF unit, making it simple and economically viable for investors. Another benefit is that most ETFs immediately reinvest dividends received from companies whereas the exact timing of reinvestment might differ in the case of growth index mutual funds.
ETFs are well-suited for novice or young investors with a small investment corpus. It enables an individual to construct a cost-effective diversified portfolio. Investing in ETFs is not completely utopian; there are drawbacks like – excessive trading of ETFs leads to high transaction costs thereby, reducing the overall performance, and not all ETFs are low-cost, liquid, and finally, tracking error. Ergo, thorough due diligence is a must on the investor’s part.