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CAPITAL CAPITAL MARKET
MARKET
f. Redemption Process
There are a few ways of redemption of ETF
shares :
● For redemption of ETF, investors may sell shares
on the open market—the more common option for
investors.
● The second option is to hoard enough ETF shares
to form a creation unit and then exchange the creation
unit for an underlying security—the option more
generally associated with institutional investors
because of the large volume of shares required.
● When investors redeem, the creation unit is no
more and the securities are handed over to the
redeemer.
How do ETFs generate returns for investors?
ETFs, as earlier mentioned, are like stocks and are
traded like a stock. So the price of an ETF share
depends on the forces of supply and demand in the
market and on the performance of the underlying
index.
In order to understand ETFs better we tried to give
a brief about couple of ETFs traded in different
exchanges and are a replica of Indian index.
Methodology
The methodology used for was to study the
difference of mutual fund and ETFs. This will help
passive investor to make the investment decisions.
Also, a comparative analysis of ETF and shares will
help us know how well are ETFs for active investors.
During the study a sample of two ETF iShares S&P
India Nifty 50 Index Fund and PowerShares India
Portfolio ETF is also taken to understand the
composition of ETFs. The samples taken are the ETFs
traded in US market but are fund based in Indian
Index.
Analysis
Precisely, ETFs are like mutual fund which trades
like a stock. It can be used for speculative trading like
short selling and trading on margin. It has low expense
ratio. Just like a stock it can be traded through
brokerage firm. A commission charge is incurred in
each trading. It gives the opportunity to an investor
to diversify its portfolio.
In mutual fund, whose pool of money is invested
by the fund manager is based on the goals of the funds.
The trading of the different positions is done throughout
the year but the information is published quarterly
i.e. the fund is not transparent but ETFs mention the
details like the sector they have invested and the
equity they are holding—this information is available
at all times.
Second major differencde between mutual fund
and ETFs are that MF can be valued at that day’s
closing price so it cannot be traded throughout the
day unlike ETFs which are constantly valued on their
underlying holdings and are traded on the real time
basis. The last major difference between them is the
annual fee charges. MF tends to charge tentatively
between 1-2% but ETF’s annual charges may be as
low as 0.1%.
Comparative analysis of Shares, ETFs and
traditional managed fund shows that Exchange traded
Funds has the benefit of a stock and a traditional
managed both :
● It has high level of diversification which is
lacking if an investment is done in shares and
is dependable on the type of securities in case
of traditional funds.
● It can be traded on intra-day pricing like a
share, unlike a traditional fund which is traded
on the market close value.
● Liquidity is comparatively high as compared
to shares and funds.
● The ETFs information is very transparent. At
any given point of time an investor can know
all the related information of the ETFs from the
sectors it has invested into to the shares it is
holding.
● It can be used in short selling and limit order
just like a share.
Diversification
of investment
Pricing
Liquidity
Transparency
772 The Management Accountant |September 2011
Fee
Short-selling
(of investment)
Limit order
Share
Low—Individual
securities
Continuous intraday
pricing
Varies
n/a
Varies, but multiple
trades may increase
transaction costs
Yes
Yes
ETF
High—Basket of
securities
Continuous intraday
pricing
Comparatively
higher
Fund holdings disclosed
as often as
daily
Comparatively
lower due to fewer
trades and index
style investing
Yes
Yes
Traditional Managed
Fund
Depends on different
funds—Basket of
securities
Daily quote after
market close
Varies between daily,
monthly, and quarterly
Varies
Varies, but active
funds generally incur
higher management
costs
No
No
Source : http://sq.ishares.com/about ishares/structure
ishares.htm
Table 2
The snapshot of difference between shares, ETFs
and traditional managed funds are shown is Table 2.
In Indian context, around 80% Indians who invest their
money are from middle class and are risk averse. They
want a high rate of return from less risk. ETFs fit the