Exchange Traded Fund (ETF) is in news as the government has decided to use ETF mechanism to disinvest the shares of public sector companies. The idea is to cumulate the shares of selected PSUs proposed for disinvestment under a single fund (that forms the base of Exchange Traded Fund). Then these cumulated shares are divided into different units/shares (as in the case of mutual funds). The value of one unit (or ETF unit/share) depends upon prices of underlying PSU shares. These units can be listed in the stock exchange as ETF and can be traded like ordinary shares. The advantage is that listing and trading in stock exchanges gives tradability (easy for buying and selling) to the ETF shares. This will attract investor participation in ETFs. Retail and institutional investors will easily trade this ETF shares as the ETF has high liquidity as in the case of ordinary shares.
For the government, ETF route will help to avoid the cumbersome exercise of several IPOs (Initial Public Offerings). Otherwise, each PSU disinvestment necessitate separate listing or IPOs. Similarly, investor participation will go up.
What are exchange traded funds?
An ETF is a type of fund that owns the underlying assets and is divided into different shares. It is a marketable security (in the form of shares) that contains a slice of cumulated shares/bonds/commodities/foreign currencies that is sliced into different shares. Gold ETF is an important instrument in the NSE. Following are the main features of ETFs.
- ETFs as funds owns underlying assets like shares of different companies.
- The shares of different companies are pooled together and these cumulated shares form the asset base of ETFs.
- Then the cumulated assets are divided into different units and these units are listed and traded in the stock exchange as ETFs.
- These ETFs that are listed in the stock exchanges are considered like shares (of ETFs) and can be traded like ordinary shares.
- Thus, the ETFs are listed and traded in the stock exchange like shares.
- The ETFs trading value is based on the net asset value of the underlying stocks that it represents.
- In nature, the ETFs are index funds (funds that comprised of shares of different companies – indexation)
ETF vs Mutual Funds
Mutual fund is like an ETF as it is a unit that comprised of equities of different companies. But ETF and mutual funds differ with respect to tradability. Mutual Fund selling price will be the price of shares at the close of the day. On the other hand, shares of ETF are traded throughout the day. And at any moment, ETF can be bought and sold. In this respect, ETFs have more liquidity and marketability. Another difference is that Mutual Fund is managed by a financial company and its fund managers; whereas the ETF is managed by the investor himself (unless deputed).
ETFs experience price changes throughout the day as they are bought and sold. ETFs typically have higher daily liquidity and lower fees than mutual fund shares, making them an attractive alternative for individual investors.