16.9 Exchange traded funds (ETFs)

Exchange Traded Funds are mutual fund units which investors buy/sell from the stock exchange, as against a normal fund unit, where the investor buys/sells through a distributor or directly from the AMC. ETF as a concept is generally new in India. ETFs enable investors to gain broad exposure to entire stock markets as well as in specific sectors with relative ease, on a real-time basis and at a lower cost than many other forms of investing. An ETF is a basket of stocks that reflects the composition of an index, like S&P CNX Nifty, BSE Sensex, CNX Bank Index, CNX PSU Bank Index, etc. The ETF’s trading value is based on the net asset value of the underlying stocks that it represents. It can be compared to a stock that can be bought or sold on real time basis during the market hours. The first ETF in India, Benchmark Nifty Bees, opened for subscription on December 12, 2001 and listed on the NSE on January 8, 2002.

ETFs have relatively lesser costs as compared to a mutual fund scheme. While in case of a mutual fund scheme, the AMC deals directly with the investors or distributors, the ETF structure is such that the AMC does not have to deal directly with investors or distributors. Instead, it issues units to a few designated large participants, who are also called Authorized Participants (APs) who in turn act as market makers for the ETFs. The authorized participants provide two way quotes for the ETFs on the stock exchange, which enables investors to buy and sell the ETFs at any given point of time when the stock markets are open for trading. ETFs therefore trade like stocks. Buying and selling ETFs is similar to buying and selling shares on the stock exchange. Prices are available on real time and the ETFs can be purchased through a stock exchange broker just like one would buy/sell shares. Because of this, obviously there is huge reduction in marketing expenses and commission. Why? Because Authorized Participants are not paid by AMC but they get their income by offering two-way quotes. Practically, any asset class can be used to create ETFs. Globally, there are ETFs on silver, gold, indices, etc. However, in India we have ETFs on gold and indices.