Among the various products launched of late, exchange-traded funds are gaining momentum in the country. This is a welcome move as it signifies that India is catching up with the developed markets.

A famous age-old adage says, You cant eat your cake and have it too. However, if an investor wants to have the cake and eat it too, he must surely choose the Exchange-Traded Fund (ETF). ETFs are mutual funds that are listed and traded on the stock exchange. So far, we have five ETFs in India, of which three are based on the 50-share S&P CNX Nifty index, one on the 200-share CNX Nifty Junior and the third on the 30-share Sensex. In India, the concept of ETFs is still evolving.

However, in developed economies it has received an enthusiastic response. ETFs can be categorized as open-ended or close-ended and actively managed or passively managed. ETFs were launched with much fanfare a couple of years back, but were deprived of the deserved recognition. Experts opine that the perception that ETFs trade at a discount to their Net Asset Values (NAVs) has created misconceptions about ETF management. However, the reality is far different from this perception and they dont trade at a discount to their NAVs. Ideally, their low expenses make them a compelling investment for the cost-conscious mutual fund investor. Another factor is the performance of ETFs which is closely linked to that of their benchmark indices.

The ETFs normally track an index so that they mirror the performance of the index and this usually makes it a passive fund. So the returns from ETFs will be equal to the rise in the index. While Indias growing market offers huge opportunities in the non-index funds and actively managed funds, they may beat the returns generated from index-based funds. Investors can either purchase ETFs on the exchange or opt for the cash subscription route in which they can pay cash directly to the fund for purchasing the portfolio. ETFs can be traded intra-day and they provide an opportunity for the arbitrageurs to create and redeem units every day on the direction of shorter-term market movements through the trading of a single security. As such, arbitragers can take advantage of a significant premium or discount between the ETF market price and its NAV relative to the underlying index. However, the intra-day trading will lose its popularity among the long-term investors.

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