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What is ETF
In summary
An Exchange-Traded Fund, or ETF, combines features of a mutual fund and a stock. It holds a basket of assets, while its units are bought and sold on a stock exchange during market hours.
- ETF stands for Exchange-Traded Fund.
- ETFs can track indices, sectors, bonds, commodities, or international markets.
- You generally need a demat and trading account to trade ETF units.
- ETF prices can change throughout the trading day.
- The market price can differ from the ETF's NAV.
- Costs may include an expense ratio, brokerage, and applicable demat or transaction charges.
- SEBI's August 2026 data recorded 267 equity ETFs and 38 debt ETFs.
- The SEBI Riskometer uses six risk categories, from Low to Very High.
An ETF can provide diversification through one investment, but it does not remove market risk. The risk depends on the assets or index the ETF tracks.
What is an ETF?
ETF stands for Exchange-Traded Fund. It is a fund that holds a collection of assets and whose units are traded on a stock exchange, similar to shares.
An ETF may track a broad market index such as the Nifty 50 or Sensex. Other ETFs may track a particular sector, bond index, commodity, or international market.
For example, instead of buying shares of each company in an index separately, you can buy units of an ETF that tracks that index. This gives you exposure to the basket of securities held by the ETF.
An ETF can therefore provide diversification through a single investment. However, diversification does not remove investment risk.
SEBI explains that ETFs track indices and trade on stock exchanges, with their market prices changing during the trading session.
How do ETFs work?
Most ETFs in India are designed to track a particular index or asset. The fund holds the securities or other assets specified by its investment strategy.
Suppose an ETF tracks an index containing 50 companies. If the index changes, the ETF's portfolio is adjusted according to the scheme's mandate.
ETF units can then be bought or sold on the stock exchange during trading hours. Unlike a conventional mutual fund transaction, where the applicable NAV is used for processing the transaction, an ETF trades at the market price available on the exchange.
The market price can be different from the ETF's NAV. Supply and demand, trading activity, and market conditions can affect the price at which you buy or sell an ETF.
Creation and redemption
ETF creation and redemption is generally handled through authorised participants. When new units are required, authorised participants can provide the underlying basket of securities or other permitted assets to the fund and receive ETF units. The reverse process can occur when units are redeemed.
This mechanism helps support trading and can help keep the ETF's market price relatively close to its NAV. However, there is no guarantee that an ETF will always trade exactly at its NAV.
What types of ETFs are available in India?
ETFs can be classified according to the assets, index, sector, or strategy they track.
- Index ETFs: Track broad indices such as the Nifty 50 or Sensex.
- Gold and silver ETFs: Track the price of the relevant precious metal.
- Sectoral ETFs: Focus on a particular sector, such as banking or technology.
- Bond ETFs: Track indices made up of fixed-income securities.
- International ETFs: Provide exposure to overseas markets or indices, subject to the scheme's structure.
- Smart beta ETFs: Use an index methodology based on factors such as value, quality, momentum, or low volatility.
- Commodity ETFs: Provide exposure to commodity prices or related assets.
Not every ETF follows a traditional market-capitalisation index. Therefore, check the ETF's underlying index or investment strategy before investing.
What are the benefits and limitations of ETFs?
ETFs can offer several features that may be useful to investors, but they also have limitations.
| Feature | What it means for you |
|---|---|
| Diversification | One ETF can provide exposure to a basket of securities or other assets. |
| Exchange trading | You can generally buy or sell units during market hours through the stock exchange. |
| Transparency | The ETF's portfolio and NAV are disclosed according to applicable requirements. |
| Costs | ETFs have an expense ratio, and you may also incur brokerage, transaction, or demat-related charges. |
| Flexibility | You can place market or limit orders through your trading platform. |
| Liquidity | Liquidity depends on trading activity in the ETF and the liquidity of its underlying assets. |
SEBI notes that ETFs can offer diversification and exchange-based trading, but investors may also face brokerage and demat charges, and ETF units cannot generally be bought or sold in fractional quantities.
What risks should you consider before investing in ETFs?
An ETF's risk depends largely on what it tracks. An equity ETF, gold ETF, bond ETF, and international ETF can therefore have different risk characteristics.
Market risk
If the underlying assets fall in value, the ETF's NAV and market price can also fall. You can therefore lose part or all of the amount invested.
You can read more about market risk.
Tracking error
An ETF may not exactly match the return of its underlying index. The difference between the ETF's performance and its benchmark is known as tracking error.
Expenses, transaction costs, portfolio adjustments, and the way the index is replicated can contribute to tracking differences.
Liquidity risk
An ETF being listed on an exchange does not automatically mean it will have high trading volume. An ETF with limited trading activity may have a wider bid-ask spread, making it harder to buy or sell at your preferred price.
You can learn more about liquidity risk.
Concentration risk
A sectoral or thematic ETF may hold securities concentrated in one sector or theme. If that area performs poorly, the ETF may be affected more significantly than a broad-market ETF.
Currency risk
International ETFs can be affected by movements in the exchange rate between the Indian rupee and the relevant foreign currency.
Credit and counterparty risk
Bond ETFs can carry credit and interest-rate risks. ETFs using derivatives or securities-lending arrangements may also have counterparty exposure.
You can read about credit risk and investment risk.
How much does it cost to invest in an ETF?
The main fund-level cost is the expense ratio. It covers expenses associated with managing and operating the ETF.
You may also incur costs when buying or selling ETF units, such as brokerage and applicable exchange, transaction, or demat charges.
A lower expense ratio can reduce the cost of holding an ETF, but it should not be the only factor you consider. Compare the ETF's tracking performance, liquidity, underlying index, and other applicable costs as well.
Learn more about expense ratios.
A practical example
Suppose Ananya wants exposure to a broad equity index but does not want to select individual shares herself. She considers an ETF that tracks that index.
Before investing, she checks the ETF's underlying index, expense ratio, tracking error, trading volume, bid-ask spread, and risk level. She also checks whether the investment fits her financial goal and investment horizon.
If the ETF is trading at Rs. 205 per unit and Ananya buys 10 units, her purchase value is Rs. 2,050, excluding applicable charges. If the market price later falls to Rs. 185, the value of those 10 units becomes Rs. 1,850 before charges and taxes.
The example shows that diversification does not prevent an ETF's value from falling.
How are ETFs taxed?
ETF taxation depends on the type of ETF, the assets it invests in, the applicable holding period, and the tax rules in force when you transfer the units.
For equity-oriented ETFs that meet the conditions for the relevant equity capital-gains provisions, current tax rules provide for 20% short-term capital gains tax under Section 111A for transfers on or after 23 July 2024. Long-term capital gains covered by Section 112A are taxed at 12.5% above the applicable Rs. 1.25 lakh annual exemption, subject to the relevant conditions.
Other ETFs can have different tax treatment. Do not assume that the tax rules for an equity ETF automatically apply to gold, commodity, debt, or international ETFs.
For current information, see short-term capital gains and long-term capital gains.
Tax rates mentioned above are subject to applicable surcharge and cess, where relevant. Check the latest tax rules before making an investment decision.
How can you choose an ETF?
Start by identifying what you want the ETF to give you exposure to. Then compare the features that can affect your investment.
- Investment objective: Understand what the ETF is designed to track.
- Underlying index or asset: Check what determines the ETF's performance.
- Risk: Consider the risks associated with the underlying assets.
- Expense ratio: Compare the ongoing fund-level cost.
- Tracking error: Check how closely the ETF has followed its benchmark.
- Liquidity: Review trading volume and bid-ask spreads.
- Investment horizon: Consider how long you can remain invested.
Risk tolerance: Make sure the investment fits your ability and willingness to accept losses.
You can learn more about asset classes and risk tolerance.
The benefits of ETFs can help you understand why investors use ETFs, but benefits should always be considered alongside the associated risks.
How is an ETF different from an index fund?
Both ETFs and index funds can track a market index, but they differ in how you buy and sell them.
| Basis | ETF | Index fund |
|---|---|---|
| Trading | Bought and sold on an exchange during market hours | Transactions are processed at the applicable NAV |
| Price | Market price changes during the trading session | Applicable NAV is used for the transaction |
| Account | Requires a demat and trading account | Can generally be held without exchange trading |
| Order type | Market and limit orders can be used | Orders are not placed like exchange-traded shares |
| Costs | Expense ratio plus applicable trading-related costs | Expense ratio and applicable scheme costs |
The choice depends on how you prefer to invest and manage your portfolio.
How are ETFs different from individual stocks and mutual funds?
An ETF is different from an individual stock because one ETF unit represents an interest in a portfolio rather than one company's shares.
It differs from a conventional mutual fund mainly in its trading mechanism. ETFs trade on an exchange during market hours, while mutual fund transactions are generally processed using the applicable NAV.
An ETF can therefore combine portfolio diversification with exchange-based trading. However, the level of diversification depends on the ETF's underlying portfolio. A narrowly focused sector ETF may not provide the same diversification as a broad-market ETF.
How can you invest in an ETF?
You generally need a demat and trading account to buy and sell ETF units on a stock exchange.
Steps
- Complete account opening: Open a demat and trading account with a suitable intermediary.
- Research the ETF: Check its underlying index or asset, expense ratio, tracking error, liquidity, and risk.
- Fund your account: Add the amount you intend to invest.
- Place an order: Select the ETF, enter the number of units, and place your order.
Review the investment: Monitor the ETF and its underlying exposure in line with your financial plan.
The Bajaj Broking website provides access to market investments, subject to applicable account and regulatory requirements.
Conclusion
An ETF gives you exposure to a basket of assets while allowing you to buy and sell its units on a stock exchange during market hours. ETFs can track broad indices, sectors, bonds, commodities, or international markets.
Before investing, understand what the ETF tracks, check its liquidity and tracking error, compare costs, and consider the risks associated with its underlying assets. A diversified ETF can reduce dependence on one security, but it cannot eliminate market losses.
Mutual funds are subject to market risk. Please read the scheme-related documents carefully before investing.
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What does ETF mean in simple words?
ETF means Exchange-Traded Fund. It is a fund that holds a basket of assets and trades on a stock exchange like a share. Depending on the ETF, the basket may contain shares, bonds, commodities, or other permitted assets. The ETF's value generally moves in line with the assets or index it tracks, although its market price can differ from its NAV.
Can I sell an ETF whenever I want?
You can generally place a sell order during stock-exchange trading hours, provided the ETF is trading and there is a buyer for your order. However, an ETF does not guarantee that you will be able to sell immediately at your preferred price. ETFs with lower trading volumes may have wider bid-ask spreads or less liquidity.
Is an ETF safe to invest in?
An ETF is not risk-free. Its risk depends on the assets or index it tracks. A broad equity ETF can fall when the stock market declines, while a sector ETF can be affected by events specific to that sector. Check the ETF's underlying exposure, risk factors, liquidity, and tracking performance before investing.
Can I invest a small amount in an ETF?
You generally need enough money to buy at least one ETF unit, along with applicable charges. Unlike a mutual fund SIP, you cannot normally buy a fraction of an ETF unit on the exchange. The price of one unit varies between ETFs, so the minimum amount needed also varies.
Are ETFs cheaper than mutual funds?
ETFs often have relatively low expense ratios, particularly passive ETFs, but the total cost is not limited to the expense ratio. You may also pay brokerage and applicable exchange, transaction, or demat-related charges. Compare the overall costs and tracking performance rather than assuming that every ETF will cost less than every mutual fund.
Disclaimer
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