The ETF trap you must dodge

Your ETF might look perfect until the day you try to sell it. Most investors check the index, and some glance at the expense ratio. But few ask the one question that matters when markets turn: Can I exit this ETF fast and at a fair price? This in-depth analysis reveals the hidden liquidity trap in India’s rapidly growing ETF market. We name the funds that could trap your money… and the few that won’t. If you own or plan to own ETFs, you need to read this before your next trade. Because by the time you realise what’s illiquid, it may already be too late.

 

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Most investors choose ETFs by looking at their index, expense ratio or past returns. But there’s one more factor that can make or break your ETF investment experience: Liquidity. Because even the best-performing ETF can turn into a poor investment if you can’t exit it smoothly.

For the uninitiated, liquidity tells you how easily and efficiently you can buy or sell an ETF on the stock exchange. If trading volumes are low, you may have to wait longer to sell. Worse, you may be forced to sell for less due to poor demand (less buyers in the market).

This is where ETFs differ from mutual funds. In mutual funds, you transact directly with the fund house at the day’s NAV (net asset value). But with ETFs, you buy or sell units on the stock exchange. This makes liquidity a critical part of the ETF experience.

So, how liquid are ETFs, really? Let’s break it down — category by category — and see which ETFs are actually easy to trade, and which ones might trap your money when you need it most.

Large-cap ETFs

They may track the biggest companies in the country, but only a handful of large-cap ETFs are actually big enough in trading volume. Of the 62 ETFs in the large-cap category, the top 10 ETFs in this category account for over 90 per cent of the total average daily turnover for the last one year. Even more striking: Three ETFs alone — yes, just three — make up nearly 70 per cent of the entire category’s daily trading volume.

So, while it may look like there’s plenty of liquidity in the large-cap ETF universe, the reality is that most of that action is concentrated in a very small club. If you stray outside these top-traded names, you risk holding an ETF that’s easy to buy but frustratingly hard to sell.

Mid-cap ETFs

Mid-cap ETFs sound like a great way to tap into India’s growth engine, but good luck investing or exiting them if you don’t choose wisely. Why? Of the 13 mid-cap ETFs present in this category, the top 3 ETFs alone account for over 75 per cent of average daily turnover. Another point you need to bear in mind is that the average daily turnover for the overall mid-cap ETF universe is significantly lower than large-caps, making up only 10 per cent of the total large-cap ETFs’ average daily turnover.

Small-cap ETFs

There are just three small-cap ETFs, which is one reason why the average daily turnover in a year is just Rs 23 crore, far smaller than that of large-cap (Rs 320 crore) and mid-cap categories (Rs 30 crore). In fact, there’s only one ETF that takes the lion’s share of trading values, deriving a little over 60 per cent of the turnover.

So, for investors hoping to invest in small caps via ETFs, remember this: Your money might be invested smoothly, but getting it out quickly and efficiently could prove difficult, especially in a downturn when liquidity truly matters.

Gold ETFs

Gold ETFs have long been the go-to choice for digital gold investing, but not all that glitters is liquid. Of the 20 ETFs in the universe, the top three gold ETFs account for more than 70 per cent of the category’s total trading turnover.

A low-volume gold ETF can significantly deviate from its NAV when you most need it to reflect real value.

So, how to check for liquidity?

The easiest way to check liquidity for an ETF is to search the respective ETF’s name in either the BSE (Archives section) or NSE (Historical data section) website. Both sites will tell you how much an ETF has been traded on a given day. By scanning this data over a few dates, you can get a quick sense of how actively the ETF is traded.

The last word

Here’s the hard truth: Only a few ETFs are liquid, while the rest are, for all practical purposes, dormant. What appears to be a diverse universe is actually a shallow pool, where only three to five ETFs per category are liquid and realistically investable.

To sum up, when it comes to ETFs, liquidity isn’t just a feature; it’s your exit plan. Choose the wrong ETF, and even a perfect index won’t save you from a poor investment experience.

An investor education and awareness initiative of Nippon India Mutual Fund.

Helpful Information for Mutual Fund Investors: All Mutual Fund investors have to go through a one-time KYC (know your Customer) process. Investors should deal only with registered mutual funds, to be verified on SEBI website under 'Intermediaries/Market Infrastructure Institutions'. For redressal of your complaints, you may please visit www.scores.gov.in. For more info on KYC, change in various details and redressal of complaints, visit mf.nipponindiaim.com/InvestorEducation/what-to-know-when-investing.

Mutual fund investments are subject to market risks, read all scheme-related documents carefully.

Also read: The essential guide to choosing the right ETF

This article was originally published on June 19, 2025.