Exchange Trading Funds or ETFs are passive or active investment instruments that track the performance of an index. The fund houses pool the financial resources of several individual investors and then use it to purchase tradable monetary assets. They do not aim to outperform the index but rather match their composition.

The prices of ETFs fluctuate every day. The net asset value of their components determines their value.  A higher liquidity and a lower fee have led to their popularity.

How do ETFs work?

ETFs have the features of both shares and mutual funds. They are generally traded in stock markets, bought and sold as per demand and supply factors during trading.

As we discussed above, their price depends on the net asset value of their underlying assets. Moreover, the dividend that the shareholders finally receive depends on the overall performance of the concerned ETF.

Here are the types of ETFs as per their management – 

Actively managed ETFs

Portfolio managers operate them after carefully studying the current stock market conditions. Companies with high potential are targeted under this type of ETF.

Passively managed ETFs

Passively managed ETFs mirror the trending indices. They only invest in those companies which are on top of the charts.

Types of ETFs in India

Equity ETF

The companies which invest the funds in shares or other forms of equities fall in this category.

Gold ETFs

Gold ETFs involve trading in physical gold assets. By investing in such companies, you can own gold on paper without worrying about asset protection.

Debt ETF

Such enterprises deal with instruments offering fixed returns, like government bonds.

Currency ETF

A few currencies that are likely to perform well in the future tend to attract investments through careful predictions. The gains are dependent on exchange rate fluctuations. They also reflect the political and economic scenario of countries and their inter-relationships.

How are ETFs taxed?

ETF tax treatment differs on equity-oriented and non-equity-oriented ETFs. They attract Securities Transaction Tax.

Equity-oriented funds

Equity-oriented schemes are index ETFs and equity ETFs. Capital gains made on them for less than 365 days are taxed at 15 percent plus 4 percent CESS. On the other hand, units held for more than a year are taxed at 10 percent, without indexation benefits. ETF tax on long term capital gains up to Rs. 1 lakh is nil.

Non-equity-oriented funds

Gold and International ETFs are treated as non-equity ETFs. ETF tax on short term gains for less than 36 months is applicable as per the income tax slab rate. However, long term capital gains over a year are taxable at 20% after indexation benefit.

What are the advantages of ETFs?

The advantages of ETFs are –

Diversification

ETFs provide immense diversification and can track a broader range of stocks. One ETF can give exposure to an array of market segments, a group of equities across different sectors.

Trades like a Stock

While ETFs come with diversification benefits, they also have the liquidity of equities. Some points which exemplify this are –

  • – ETFs can be sold short. It is possible to purchase them on a margin too.
  • – Their prices are continually updated throughout the day.
  • – Just like a stock, they allow you to manage risks by trading futures and options.

Since ETF trading is very similar to stocks, you can track their approximate daily price change through the ticker symbol. Many stock websites have even come up with mobile devices applications for investors to view price variations in real-time.

Tax-efficient

Passively managed ETFs attract lesser capital gains tax and, thus, are more tax efficient. Moreover, buying and selling of shares by an ETF is considered to be in-kind redemption. They do not attract any tax charges.

Things to consider before investing in ETFs

  • – Study the investment horizon before investing in the ETF. Long term investments will reduce your tax liability.
  • – Having a crystal-clear investment strategy is crucial for choosing the right ETF. It would be best to analyse whether your portfolio is composed of a broader market index or a specific sector.

Conclusion

A large number of investors use ETFs to gain exposure to several sectors. If used correctly, they can ensure humongous returns.

If you have any queries regarding the ETFs, our experts at Angel Broking, one of India’s leading brokerage houses, will be happy to assist you.