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Exchange Traded Funds : Merits And Demerits

Updated on July 4, 2015

Introduction

Exchange Traded Funds are the Funds which traded through exchanges. It is really an evolution in the field of investment. Through the ETFs, the concept of investment through Exchanges had utterly changed. We can now earn a fixed income like bank fixed deposit by investing in Liquid base ETFs. Also to fight with inflation or depreciation of money value, we can invest in the ETF based on the precious metal Gold. They are a type of mutual fund. Mutual funds are under the strict scrutiny of a Fund manager. The Net Asset Value of Exchange Traded Funds are based on the Index of an exchanges like Dow Jones, Nasdaq, FTSE, CAC, DAX, Nikkei225, Hang Seng, KOSPI, Shanghai, SENSEX, NIFTY are examples for various world indexes. In USA, the Exchange Traded fund begin in 1993. After six years (1999), it starts in Europe also. Basically an ETF is an indexes Fund. But in 1999,the US Securities andu Exchange Commission approved the actively managed ETF as same as a mutual fund.

Calculation of NAV

The calculation of the Net Asset Value of an ETF is more easier than of a mutual fund. The NAV of an ETF will almost fall and rise as same as the index on which it is based. For Example, Nifty Bees is based on the Indian index Nifty 50. The value of one unit of this ETF is one tenth of Nifty 50. When Nifty 50 is on the point of 5000, its value will be 500 Rupees. It is almost same in the cases of other ETFs also. Their value may vary as one out of hundred or one out of 1000 of Indexes.

Various Types of ETF

There are various types of ETFs. ETFs are not only on indexes of Equity Stocks, but also on bonds, liquids, metals and commodities also. There are ETFs based on Equity are depends various Indexes like largecap, midcap, smallcap and multicap stocks. The volatily in Largecap funds will be a little, while in small cap finds will be huge. For a fixed return, an investor should select the ETF based on bonds and income or liquid assets. Metal and commodity ETFs can be used for increasing the variety of one's investment. At a time, the value of all types of investment should not fall or rise alike.

Merits

ETFs have the dual nature of a stock and a mutual fund. It can be buy or sell easily like a share through the terminals of a stock exchange. But a stock is more volatile than a mutual fund. In the same time, volatility of an ETF is as same of a mutual fund. It means the risk of investment in an ETF is less than the investment in a stock. But the lliquidity of an ETF is as same as a stock and more than a mutual fund. Thus an ETF exhibits the advantages of both a stock and mutual fund. The rise and fall of values of a stock can not predict by seeing the variation of value of an index. But the value of an ETF can easily predict by seeing an index. It is another good quality of an ETF and an investor can easily and suddenly determine the investment strategy every day and not wait for the declaration of NAV from the company. The bad performance in an audited accounts of a single stock in the index never affect the value of an Exchange Traded Fund as same as that stock. This is same in the case of a mutual fund.

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Demerits

Return from good stock change the fate of an investor as it grow through the rise in the stock value, dividends, bonus shares and division of shares. A good stock will grow 1000 times within a small period like a decade. But an ETF never give such a return. It grow with all stocks in the index. An ETF will bear the falls of bad stock in the index while it grow with good stock in that index. A well actively managed mutual fund will also give good return than an ETF. The variation in growth may doubled or tripled sometimes.

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    • nancynurse profile image

      Nancy McClintock 4 years ago from Southeast USA

      Great hub. Thanks for sharing!

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