Exchange traded funds: Know how to select the right ETF

Retail investors are increasingly investing in exchange traded funds (ETFs) because of low costs and returns mirroring an index. Assets under management of passive funds touched Rs 5.2 trillion in March this year, a growth of over 2.5 times in the last two years. Of this, Rs 4.1 trillion alone is contributed by ETFs.

Investors need to look at various factors before choosing the right ETF. For one, they should opt for the one which has high trading volumes and good liquidity. Next, they should look at the expense ratio and the tracking error.

Select the right ETF
Investors need to look at the asset class they want to invest as ETFs offer exposure to equity, debt, commodities and global equities. Once the investor has zeroed in on the asset class, say, equity, he needs to identify which index—large cap indexes such as Nifty and Sensex or sectoral indices such as banking or technology—within equity that he wants to get access to. Ashwin Patni, head, Products & Alternatives, Axis Mutual Fund, says once the investor has identified the index, he will see that there is also a lot of choice in terms of multiple fund managers that may be offering an ETF for that particular index. “So depending on which fund house they want to go with they can then invest in the particular ETF,” he says.

Manish Kothari, co-founder and CEO, Zfunds, a mutual fund distribution platform, says the first parameter should always be the volumes as even if any ETF is good in terms of expense ratio and tracking error, the high transaction costs of an illiquid security will undo those positive scores.

Consider ETF liquidity
Retail investors must consider the liquidity while selecting the ETF. In fact, in case of big-ticket investments which are generally made by institutional investors, they can get liquidity from the asset management companies directly. But retail investors who will be making small investments can face high liquidity issues in ETFs having low trading volumes. So, it will become difficult for them to…

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