Exchange traded funds (ETFs) are a category of mutual funds that have the characteristics of a mutual fund but are traded like shares during trading hours in the stock market. ETFs represent baskets of assets traded on exchanges, often mirroring indices like the Nifty 50 or BSE Sensex.     

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However, unlike mutual funds, where one buys and sells units based on the price of the net asset value (NAV), or unit, at the end of the day, ETFs can be bought and sold during market hours at the current market price. 

ETFs are similar to trading stocks, but they have a few advantages over stock trading.

ETFs don't have lock-in periods; by investing in a variety of assets, they help you spread risk across multiple securities, granting exposure to a wide range of companies, including large caps. 

"ETFs typically have lower expense ratios in comparison with passive funds, which makes them a cost-effective choice for diversified portfolios. They also have a lower tracking error on average, which essentially means they’re tracking the index more accurately than Index Funds," says Kavitha Subramanian, co-founder of the of the Upstox app. 

Many of the ETFs have given returns of over 50 per cent in the one-year period. They are-

CPSE ETF- 99.74%
Kotak PSU Bank ETF- 70.14%
Nippon ETF PSU Bank BeES- 70.04%
SBI ETF Nifty Next 50- 59.63%
Nippon ETF Junior BeEs- 59.55%
Mirae Asset Nifty Next 50 ETF- 59.45%
Motilal MOSt Oswal Midcap 100 ETF- 54.93% 
ICICI Pru Midcap Select ETF- 54.93%
Nippon ETF Infra BeES- 52.98%

How to select ETFs for investment?

Kavitha says that apart from the tracking error and the expense ratio, other factors to consider while analysing an ETF are liquidity, fund size, and past performance. 

"Higher liquidity and a larger fund size of an ETF signify stability and fewer price fluctuations. Lower expense ratios positively impact long-term returns, while lower tracking errors indicate efficient tracking of benchmark indices."

Should one invest in ETFs through SIP or lump sum?

Choosing the right investment approach, whether it's through SIPs, lump sum investments, or timing the market with ETFs during dips, depends on several factors, including your financial goals, risk appetite, investment horizon, and market conditions.

Kavitha says, "SIPs in ETFs involve investing fixed amounts regularly, providing the benefit of rupee cost averaging and reducing the impact of market volatility over the long term. This approach is suitable if you’re looking to build long-term wealth gradually and mitigate risks associated with market fluctuations." 

About lump sum investments, she says, "On the other hand, lump sum investments mean investing a significant amount of capital at once, potentially offering higher returns if the market performs well immediately after investment but carrying higher risk due to exposure to market volatility. Timing the market by buying ETFs during dips requires accurate analysis of market movements, which can be challenging and risky."

How to maximise ETF returns

While returns in mutual funds are fixed, one can extract extra returns from ETFs if they follow certain strategies. Here's what Kavitha suggests: 

One major benefit to consider with ETFs is that they can be bought at a discount and provide a chance to generate slightly more returns.

To simplify this, we’d like to break down two concepts: end of day NAV and indicative NAV.

End of day NAV will tell you the value of the ETF at the end of each trading day, but INAV will tell you the value of the ETF after every 15 seconds.

As ETFs are traded like stocks, there could be instances of INAV being higher than NAV or instances where it's lower. 

If INAV is higher than the NAV, you’re essentially paying a premium, and your returns will be lower.

But if the ETF's INAV is lower than its NAV, there’s an opportunity to buy the ETF at a discount and potentially make higher returns. 

Apart from tracking error and the expense ratio, other factors to consider while analysing an ETF are liquidity, fund size and past performance.

Higher liquidity and a larger fund size of an ETF signify stability and fewer price fluctuations.

Lower expense ratios positively impact long-term returns, while lower tracking errors indicate efficient tracking of benchmark indices.

Additionally, since ETFs can be traded like stocks, one can engage in various trading strategies as well - engage in intraday trading or swing trading.

Furthermore, ETFs can also be pledged to gain up to 90 per cent collateral margins for trading in Futures and Options (F&O).