What are Exchange Traded Funds or ETFs - Exchange Traded Funds or ETFs are passive funds. Unlike actively managed funds, ETFs aim to replicate the performance of a market index like Sensex, Nifty etc. ETFs do not aim to beat the market benchmark index. ETFs also replicate the price of commodities like Gold. ETFs are listed in stock exchanges and trade in exchanges just like shares of listed companies.

How are ETFs constructed?

ETFs invest in a basket of securities which represent a particular index. For example, a Nifty 50 ETF will invest in all the 50 stocks which constitute the Nifty 50 index. Each stock in a Nifty 50 ETF portfolio has the same weight as the index constitute. For example, if stock A has 5% weight in the index, the same stock will also have 5% weight in the index ETF.

How to buy or sell ETFs?

There are three ways of ETF investing:-

• During the New Funds Offer (NFO): You can subscribe for the ETF during the NFO. The Asset Management Company (AMC) will allot you units of ETFs at par value or face value.
• After the NFO – In stock exchanges: ETFs trade in the stock exchanges. After the NFO you can buy any number of units of ETFs from the stock exchange through your broker at prevailing price. You need to have demat and trading accounts to buy / sell ETFs or do ETF trading in stock exchanges.
• After the NFO – with the AMC: After the NFO, ETF investing can also be done through the AMC in lot sizes specified by the AMC. Usually the lot sizes are quite large – they are much larger than the average transaction size done by retail mutual fund investors.

There are two ways of redeeming your ETF units:-

• Selling it in stock exchanges: You can sell any number of units of Exchange Traded Funds or ETFs in the stock exchange at prevailing price.
• Redeem with the AMC: You can also redeem directly with the AMC in lot sizes specified by the AMC. As mentioned earlier the lot sizes are usually large; you need to have a fairly large investment to redeem your ETF mutual fund units with the AMC.

Difference between Price and NAV of ETF

Net Asset Value (NAV) of an ETF is the current market value of the basket of securities underlying the ETF less expenses and liabilities, divided by the total number of units outstanding of the ETF. It is, in a sense, the fair value of the ETF. However, you may not be able to buy or sell ETF units in the stock exchange at the NAV. The price at which ETF trading takes place in the stock exchanges is the real time market price. The premium or discount to NAV is usually low (around 1%). The more liquid an ETF, lower is the premium or discount to NAV. AMCs appoint market makers to ensure adequate liquidity for the ETFs in the stock exchanges.