Investors often confuse ETFs with conventional mutual funds. However, the fact is that they are different on several counts. Perhaps, the only similarity between ETFs and conventional mutual funds is that they both provide investors an opportunity to invest in an assortment of stocks/instruments through a single avenue.
1) First, an investor in a mutual fund needs to buy and sell units from the fund house. In case of an ETF, the transaction has to be routed through a broker as buying and selling is done on the stock exchange. In the rare case that an investor can buy or redeem units in an ETF through the fund house, it is normally done in a pre-defined lot size. Typically, the lot size tends to be substantial making it feasible only for institutional investors and high networth individuals.
2) Since ETFs are traded on the stock exchange, they can be bought and sold at any time during market hours like a stock. This is known as 'real time pricing' as ETF investors can transact at the price prevailing at that point in time. This is in contrast to mutual funds, wherein units can be bought and redeemed only at the relevant NAV; the NAV is declared only once at the end of the day. As a result, ETF investors have the opportunity to make the most of intra-day volatility. Of course, this may hold little significance for long-term investors.
3) ETFs are associated with low expenses vis-�-vis mutual funds. For example, a passively managed ETF which tracks a benchmark index (say S&P CNX Nifty) would have an annual recurring expense in the range of 0.44%-0.50%, while it would be around 1.00%-1.25% in case of an index fund tracking the same benchmark index.
Unlike mutual funds wherein entry/exit loads can vary between 2.00%-2.25%, ETF investors do not have to bear any loads. Instead they have to pay a brokerage while transacting. While brokerage rates vary across brokers, a brokerage of around 0.50% on each transaction in the Indian context can be regarded as being on the higher side. However, ETF investors must have a demat account, this in turn entails paying an annual maintenance charge (which can be about Rs 300). Since ETF investors often invest in stocks as well, the maintenance charge of the demat account can be apportioned on both the stock and ETF investments.
4) ETFs safeguard the interests of long-term investors. The reason being that since all the buying and selling of units is done on the exchange, the fund house doesn't enter the picture. Investors directly interact with other investors over the exchange. This in turn ensures that the fund manager's hand is never forced due to the buying/selling activity.
In case of mutual funds, the possibility of a substantial redemption adversely affecting the fund cannot be ruled out. For example, the fund manager might be forced to sell his best investments prematurely to meet the redemption pressure. This in turn could have a negative impact on the long-term investors' interests.
5) While mutual funds are always available at end-of-day NAV, ETFs do not necessarily trade at the NAV of their underlying portfolio. Rather, the market price of an ETF is determined by the demand and supply of its units (which in a close-ended ETF is fixed), which in turn is driven by the value of its underlying portfolio. Therefore, the possibility of an ETF trading below (at a discount) or above (at a premium) its NAV does exist.
Clearly, despite their seemingly similar structures, ETFs and mutual funds are distinct on several fronts. As always, investors should take into account their risk appetite and investment objectives, among a host of other factors; and consult their investment advisors/financial planners to determine the suitability of ETFs in their portfolios.
