What are Exchange Traded Funds (ETFs)?
- Apr 10
- 6 min read
An Exchange Traded Fund is a type of investment fund that is listed and traded on a stock exchange, just like a share of a company. When you buy units of an ETF, you are essentially buying a basket of securities that the fund holds. This basket could contain stocks, bonds, commodities like gold, or other assets, depending on the type of ETF.
The key idea behind an ETF is that it tracks an underlying index or benchmark. For example, a Nifty 50 ETF holds all 50 stocks that make up the Nifty 50 index, in the same proportion. So when the Nifty 50 goes up, the ETF goes up too. When it falls, so does the ETF. This is why ETFs are called passively managed funds: the fund manager does not pick and choose stocks based on personal judgment. Instead, the fund simply mirrors its benchmark.
An ETF (Exchange Traded Fund) is a passively managed fund that tracks an index, commodity, or basket of assets, and is bought and sold on a stock exchange like a regular share during market hours.
Think of an ETF as a container. Inside that container are securities such as stocks or bonds that replicate a particular index. When an Asset Management Company (AMC) launches an ETF in India, it works with large institutional investors called Authorised Participants (APs) to create units of the ETF. These APs deposit the actual underlying securities with the AMC and receive ETF units in return. These units are then listed on exchanges like the NSE or BSE, where you and I can buy and sell them through our Demat and trading accounts.
Because ETFs are listed on the exchange, their prices move throughout the trading day based on demand and supply. This is different from a regular mutual fund, where you can only buy or sell at the end-of-day NAV (Net Asset Value). The real-time price of an ETF closely tracks its underlying index value, which is called the iNAV or Indicative NAV.
Types of ETFs available in India
The Indian ETF market has grown significantly over the past decade. Today, you can find a wide variety of ETFs listed on Indian exchanges, each designed to give you exposure to a different asset class or theme.
Equity ETFs are the most popular category. These track stock market indices such as Nifty 50, Nifty Next 50, Sensex, Nifty Midcap 150, and sector indices like Nifty Bank or Nifty IT. They are ideal for investors who want broad market exposure without paying for active fund management.
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Gold ETFs allow you to invest in gold in electronic form, without the hassle of storing physical gold or paying making charges. Each unit of a Gold ETF typically represents 1 gram of gold (or a fraction thereof), and its price tracks the domestic gold rate.
Debt ETFs track indices composed of government securities or bonds. The Bharat Bond ETF, launched by Edelweiss AMC with CPSE backing, is a well-known example. These are suited for conservative investors who seek stable, predictable returns.
International ETFs give Indian investors access to global markets. Some ETFs track indices like the Nasdaq 100 or the S&P 500, allowing you to add geographical diversification to your portfolio without opening a foreign brokerage account.
One of the most compelling reasons investors choose ETFs is their low cost. Because ETFs simply replicate an index and do not require a team of analysts researching stocks, their expense ratios are significantly lower than those of actively managed mutual funds. In India, the expense ratios of equity ETFs can be as low as 0.05% to 0.20% per year, compared to 1% to 2% for many active funds.
ETFs also offer transparency. Since they track a publicly known index, you always know exactly what you are investing in. The portfolio composition does not change at the discretion of a fund manager. This predictability appeals to many investors who prefer to understand their holdings clearly.
Additionally, ETFs provide liquidity and flexibility. You can buy or sell an ETF any time during market hours, which gives you far more control over your entry and exit points compared to traditional mutual funds. For investors who want to react quickly to market movements or implement a tactical strategy, this is a meaningful advantage.
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Assets under management (AUM) in India's ETF segment has grown from under Rs 1 lakh crore in 2019 to over Rs 7 lakh crore by 2024, driven largely by EPFO investments and retail participation through Demat accounts.
ETFs vs Mutual Funds: what is the difference?
This is one of the most common questions among Indian investors, and rightfully so. Both ETFs and mutual funds pool money from many investors to buy a collection of securities. But there are some meaningful differences in how they are structured, traded, and managed.
The table below provides a clear side-by-side comparison.
Parameter | ETF | Mutual Fund |
Trading | Traded on stock exchange like shares | Bought/sold at end-of-day NAV |
Pricing | Price fluctuates throughout the day | Single NAV declared once a day |
Minimum Investment | Price of 1 unit on the exchange | As low as Rs 500 via SIP |
Expense Ratio | Generally lower (0.05% to 0.5%) | Generally higher (0.5% to 2%+) |
Demat Account | Mandatory | Not required |
Fund Manager Role | Passive: tracks an index | Active or passive depending on type |
Transparency | Real-time portfolio visibility | Monthly portfolio disclosure |
Exit Load | No exit load; brokerage applies | Exit load may apply on early exit |
The most fundamental distinction is in how you buy and sell them. A mutual fund transaction happens directly with the AMC, and the price you receive is the NAV declared at the end of the trading day. With an ETF, you transact on the stock exchange with another buyer or seller, and the price is determined by the market in real time.
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Another key difference is the requirement for a Demat account. To invest in ETFs, you must have a Demat and trading account with a stockbroker. Mutual funds, on the other hand, can be invested in directly through the AMC's website, a mutual fund distributor without needing a Demat account. This makes mutual funds more accessible to first-time investors who have not yet opened a brokerage account.
Mutual funds, especially those with a Systematic Investment Plan (SIP) facility, also allow you to invest with very small amounts such as Rs 100 or Rs 500 per month. ETFs, while affordable, require you to buy at least one unit, and the price of a single unit varies by fund. Some ETFs are priced at Rs 50 per unit, while others may cost Rs 500 or more.
ETFs are a particularly good fit for investors who believe in passive investing and the idea that, over the long term, most actively managed funds struggle to consistently beat their benchmark index. If you are comfortable with the concept of simply earning market returns, ETFs offer a cost-efficient way to do that.
They are also well suited for investors who already have a Demat account and are comfortable with stock market transactions. If you are an active investor who tracks markets and wants flexibility in your entry and exit, ETFs give you that control in a way that mutual funds cannot.
That said, ETFs come with their own set of considerations. One risk is tracking error: the difference between the ETF's actual returns and the index it is supposed to replicate. A well-managed ETF should have minimal tracking error, but it is worth checking this metric before investing. Another consideration is liquidity: some ETFs, especially those tracking niche indices, may have very low trading volumes, which can make it difficult to buy or sell large quantities at a fair price.
Before investing in any ETF, check its Average Daily Volume (ADV) on the exchange. An ETF with low liquidity can have wide bid-ask spreads, meaning you may end up buying at a price higher than the fair value or selling at a price lower than it. Stick to ETFs with high trading volumes and low tracking error.
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