Investing in Indices through ETFs
Since its inception, S&P BSE Sensex has generated around 15.07% CAGR returns for the investors over the last 41 years. As such, Rs. 1 lakh invested on inception of S&P BSE Sensex (Apr-1979) would have grown to Rs. 3.24 Crores as on May 31, 2020. Source: Bloomberg. Returns are based on price return variant of S&P BSE Sensex Index. Inception date: April 1, 1979
Such historical returns would be highly attractive for the investors to make their investments directly into S&P BSE Sensex. However, the benchmark index is only a scientific index comprising of shares of different companies with different weightage and not security by itself. Therefore, the investors cannot make direct investments into the index.
While the investors can have similar investment exposure by building a similar portfolio, tracking the changes in the index to replicate the index performance might be a tedious task for retail investors. Further, building a portfolio with similar weightage may call for a large investment amount. Instead, the investors can opt to invest in indices through Exchange Traded Funds (ETFs) and index funds that replicate the index within their portfolio, with an intent to replicate the returns of the underlying index/ commodity. This helps the investors to have direct investment exposure to the benchmark indices through one single investment product. Examples of such ETFs are Sensex ETF, Nifty ETF, etc.
Such a passive investing strategy aims to capitalise on the benchmark index, instead of betting on specific companies. While eliminating any personal bias in the investing decisions, the fund manager can invest only in the index constituents and in the same proportion as the index. As such, such products generally have lower expense ratios as compared to actively managed investment products, due to the relatively lesser role of fund managers in the investing decisions. Since the transaction costs in such funds are low, investing in Exchange Traded Funds (ETFs) provides a low-cost investment option to the investors with the potential of better returns.
With the minimal role of the fund manager in investment decisions, ETFs can help in the elimination of unsystematic risks for the investors. Further, the benchmark indices comprise of companies across different sectors with a proven track record and better corporate practices. So, the index investing through ETFs renders the benefit of diversification to the investors with a single investment product.
How to Invest in Indices through ETFs?
As the name suggests, ETFs can be traded on stock exchanges, just like other stocks listed on stock exchanges. The investors can trade in ETFs by placing buy and sell orders through their demat account. The investors can also check the real-time prices of the ETF units on the exchange portal and trade accordingly.
While the underlying portfolio of the ETF provides the NAV valuation for the ETF, the actual market price on the exchange may vary due to demand-supply difference. However, the transparency and convenience of ETF investing make it an attractive investment product. The buy-sell orders at the exchanges happen on a real-time basis when a buy order for investment at a specific price is matched with a sell order by any other seller at the same price. The investors can check the market depth, i.e. the list of available buy-sell orders at the exchange portal and accordingly, offer to buy and sell ETF units at a certain price.
Investing in indices through ETFs can help the investors to create a well-diversified portfolio at low cost, helping them to achieve their financial goals effortlessly over time.