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EARLIER, the exchange traded funds (ETFs) found difficulty in being accepted as a viable investment option, but now, they are quite a rage worldwide, accepted by hordes of savvy investors.
ETFs are the best ways to take a passive exposure to asset classes such as equity (via equity index), commodity (via diversified, thematic or sectoral indices), fixed income and gold.
Indian investors, however, have taken more time than their global peers to throng to ETFs. Gold ETFs have, however, attracted many domestic investors in the past two years. Equity ETFs, particularly S&P CNX Nifty ETFs, have been around for far longer than gold ETFs and yet by the end of February, there were 4.68 lakh investor folios holding units of one or more of the existing 12 gold ETFs, whereas there were only 1.46 lakh investor folios holding units of one or more of the existing 21 non-gold ETFs, mostly equity index ETFs. The collective assets under management (AUM) of gold ETFs was also much higher at Rs 9,583 crore, compared with Rs 1,672 crore in non-gold ETFs.
But ETFs carry some risks which many ETF investors may not be aware of.
ETFs are like listed stocks and, like shareholders and traders, ETF unit holders and traders buy and sell from the stock exchange during trading hours. In fact, on the first day of listing of a new ETF, the selling is by a investor who was allotted units in the new fund offer (NFO) of that ETF.
These are never typical retail investors because the minimum subscription size is usually more than Rs 1025 lakh. In gold ETFs, for instance, NFOs require a buying investor to buy about a minimum of 1 kg of gold entailing a minimum investment of more than about Rs 25 lakh.
As a retail investor, you have to, therefore, buy or sell ETFs only when they trade on the stock exchanges. It can happen that there isn't enough liquidity as a result of which the spread is very high between the best buy price and the best sell price. When you buy or sell in such a situation, your net price can tend to be far away from the real net asset value (NAV) of the ETF.
Arbitrageurs are supposed to get attracted to mis-pricings between real time traded prices in ETF and their underlying index or asset prices. So, theoretically, if the exchange-traded price of an ETF has moved up, while the underlying index has moved down, an arbitrageur would first sell ETF units on the NSE and purchase the shares of the underlying index and submit it to the asset management company (AMC) in large creation unit lot sizes to acquire units at a lower price. But, in practice, if the liquidity in the traded ETF is low, then it won't be possible for arbitrageurs to carry out such an arbitrage.
Using ETFs to carry out a long-term investment exposure entails taking on AMC risks and the risk of the ETF shutting down. Your money is not lost, but you will face a lot of inconveniences and harassment when that ETF has to be liquidated.
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