Exchange Traded Funds are an interesting variation on index funds – allowing investors to buy and sell index directly like a stock. Prudential ICICI Mutual Fund will soon launch its first Exchange Traded Fund (ETF) christened "SPIcE" (Sensex Prudential ICICI ETF). This will be the second such product in India after Benchmark AMC's Nifty Benchmark Exchange Traded Scheme (BeES).
ETFs are listed securities representing an underlying fund, which replicates a benchmark index. SPIcE will track the Sensex, whereas BeES replicates the S&P CNX Nifty. These funds trade like stocks, so they are essentially index stocks that combine the benefits of a mutual fund with a listed stock. Though, they are passively managed, they are very different from an index fund. Unlike Index funds, which are valued based on NAV, ETFs can be bought and sold throughout the trading day.
Since, the units of ETF and its underlying holdings trade separately, there can be a price disparity, i.e., it may trade at a discount or a premium to its NAV. For example, out of 200 trading days, BeES had traded at a discount on 134 days. However, the margin of discount/premium had been quite low. The maximum discount has been 1.41 per cent while the maximum premium was 0.76 per cent.
The minimum investment in SPIcE has been pegged at Rs 25,000, which is applicable only during the initial offer period. After the initial offer, to buy or sell units of ETF, an investor will have to deal with a broker who will execute the transaction.
However, a limited set of 'Authorised Participants' can create or redeem units directly from the fund in pre-defined lot sizes known as "Creation Units". The Creation Unit Size in case of SPIcE has been set as 25,000 units, whereas it is 20,000 units in case of Nifty BeES.
Apart from liquidity, the other advantages of ETFs are their low expenses and low tracking error. As ETFs are listed on the exchanges, costs of distribution and processing are less. For instance, the expense ratio of Nifty BeES is 0.80 per cent, which is lower than all the index funds currently available. And as large investors buy or redeem units in-kind (creation unit), the fund usually keeps lesser assets in cash, thus reducing the tracking error.
However, as with stocks, you will have to pay a commission to buy and sell ETF units, which can be a significant drawback for those who trade frequently or invest regular sums of money.