Friday, October 5, 2007

Exchange Traded Funds

As the name put forward, Exchange Traded Funds are a blend of a stock and a mutual fund, in the logic that:

Similar to 'mutual funds' they contain a set of particular stocks - e.g. an index like Nifty, or a commodity - e.g. gold; and

Similar to equity shares they are 'traded' on the stock exchange on real-time basis. How it works?

In usual mutual funds, one buy/sell units directly from/to the primary market. First the money is collected from the investors to form the corpus. The fund managers then use this corpus to put together and manage the appropriate portfolio/ asset allocation based on the risk profile chosen.

Whenever you would like to redeem your units, a part of the portfolio is sold and you get paid for your units. The units in conventional mutual funds are, consequently, called 'in-cash' units. But in Exchange Traded Funds, we have somewhat called the 'authorized participants' .They will first deposit all the shares that comprise the index with the AMC and receive what is called the 'creation units' from the AMC. While these units are formed by depositing underlying shares, they are called 'in-kind' units.

Payback of investing in Exchange Traded Funds
Handy to trade as it can be bought/sold on the stock exchange at any time of the day when the market is open.
You can short-sell and ETFs or buy on margin or even purchase one unit, which is not possible with mutual funds.
Exchange Traded Funds are without interest managed, have low sharing costs and negligible managerial charges. For this reason most Exchange Traded Funds have lesser expense ratios than usual mutual funds.
Exchange traded funds are not something which is directly managed by the fund managers. Therefore, does not depend on the fund managers.

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