The Exchange Traded Funds (ETFs) are relatively new products in the Indian capital market, gaining popularity among investors in India. ETF has opened investment opportunities for retail as well as institutional investors. The investors have the option to expose their portfolio to overseas stock market and sector-specific market instruments through ETF and this opportunity comes with several benefits like lower cost, real-time investment and easy accessibility as compared to other instruments in the market. The ETF on the index of foreign country is one of the latest instruments in the Indian market. But such ETFs suffer from Tracking Error, whereby there is a difference between the mean return on ETFs and mean return on its underlying asset. The proposed study is an attempt to quantify this error using the methodology prescribed by the NSE and then evaluating its impact on the investments.

A modern investor today has various investment goals and objectives which have made him look for new investment avenues. This has led to the development of various complex instruments which derive their features as a hybrid of various other financial instruments. These instruments can be even customized as per the needs of the investors. Such instruments are usually devised in the developed economies where the market regulations are comparatively lenient. In the case of the Indian capital market, the new instruments are marking their appearance and gaining popularity day by day. The Exchange Traded Fund or the ETF is one such example. ETFs are simply a pool of stocks or bonds or even both that are traded on the stock exchanges throughout the day like a single stock. They are open-ended funds that track a benchmark index and trade like a stock. In other words, they are also referred to as mutual funds which are traded on exchanges like a stock. Their modus operandi is similar to Index mutual funds, but the difference in the structure of the two explains the major difference in their investment characteristics. The other differences are based on their management style. ETFs are more elastic and translucent to trade as compared to mutual funds. Their prices are reported every 15 seconds and they can be traded the entire business day during business hours. The compositions of ETFs are declared at the end of each day. ETFs therefore provide investors an acquaintance with inexpensive beta, i.e., systematic risk, along with certain trends, sectors or asset classes. Therefore, ETFs can be considered as the more sophisticated options for a prominent risk-adjusted performance of a portfolio and to reduce the expenses relating to portfolio management. ETFs have evolved as a suave class of asset for the investors to invest in the desired benchmark in any quantity. The existing literature provides various evidences which state that in the short run, ETFs generally underperform as compared to other fund counterparts, but they overcome this situation in the long run by reducing their management expenses which are considered as one of the important reason for the occurrence of tracking error. Prasanna (2012) reported that it cannot be ignored and that though ETFs are still at a growing stage in India, they are more popular than mutual funds due to various trading advantages offered by them.

Applied Finance Journal, Evaluation, Tracking Error, ETFs, Exchange Traded Funds (ETFs), Net Asset Value (NAV), Tracker Fund (TTT), National Stock Exchange of India (NSE), NASDAQ, HNGSNGBEES, Traded in India.