What is ETF? Is it better than Other Asset Classes?

Investing can be complex with a vast array of asset classes available, and Exchange Traded Fund with its jargon ETF is no exception to this. It has emerged as a popular choice for both novice and seasoned investors. But what exactly is this instrument, and how does it stand apart from other asset classes?

First things first

What is an ETF?

An Exchange Traded Fund is a type of investment fund that holds a collection of assets—such as stocks, bonds, commodities, or a combination thereof—and is traded on stock exchanges throughout the day, much like individual stocks. This structure allows investors to gain exposure to a diversified portfolio without the need to purchase each asset individually.

Key Characteristics:

• Diversification: It offers exposure to a broad range of assets, reducing the risk associated with investing in a single security.
• Liquidity: Since they trade on major stock exchanges, investors can buy or sell shares at market prices any time during trading hours.
• Transparency: Their holdings are typically disclosed daily, allowing investors to know exactly what assets the fund contains.
• Cost Efficiency: Their lower expense ratios compared to mutual funds, make them a cost-effective investment option.

How ETFs Function in the Stock Market:

When you purchase shares of an Exchange Traded Fund, you’re buying a portion of a pooled investment that holds various underlying assets. Its price fluctuates throughout the trading day based on the value of its underlying assets and market demand. This intraday trading capability provides flexibility for investors to enter or exit positions as they see fit.

The Origin and Evolution

The concept was first introduced in the early 1990s. The first such instrument was known as the SPDR S&P 500 ETF Trust (ticker: SPY), which was launched in the United States in 1993. This groundbreaking fund aimed to replicate the performance of the S&P 500 Index, offering investors a simple way to gain broad market exposure.

Since then, the market for ETFs has grown exponentially. As of 2025, there are thousands of ETFs globally, covering a vast array of asset classes, sectors, and investment strategies. In India too the landscape has expanded significantly. The introductions like the Nifty 50 ETF and Bharat 22 ETF has provided Indian investors with accessible avenues to participate in the country’s economic growth.

Types

It comes in various forms, each designed to cater to specific investment objectives and preferences. Here’s a breakdown of the different types:

• Equity: These funds invest in a basket of stocks, aiming to replicate the performance of a specific index, such as the Nifty 50 or BSE Sensex.
• Bond: Focused on fixed-income securities, it includes government bonds, corporate bonds, or municipal bonds, providing regular interest income to investors.
• Commodity: These funds invest in physical commodities like gold, silver, or oil. For instance, Gold ETFs allow investors to gain exposure to gold prices without the need to physically own the metal.
• Sector & Industry: Targeting specific sectors such as technology, healthcare, or finance, these enable investors to capitalize on industry-specific trends.
• International: Offering exposure to markets outside of India, these can diversify an investor’s portfolio geographically.
• Thematic: Centered around specific investment themes like Environmental, Social, and Governance (ESG) factors or technological advancements like Artificial Intelligence (AI).
• Inverse & Leveraged: Designed for short-term strategies, inverse ETFs aim to profit from a decline in the underlying index, while leveraged ETFs seek to amplify the returns of the underlying index, often by using financial derivatives.

ETF vs Mutual Fund: Key Differences

The table below beautifully highlights the major differences for a fruitful comparison.

Aspect	ETFs	Mutual Funds
Trading Mechanism	Traded on stock exchanges throughout the day at market prices, like stocks.	Bought or sold at the end of the trading day at Net Asset Value (NAV).
Management Style	Passively managed; aims to replicate an index’s performance.	Often actively managed; fund managers make investment decisions to outperform the market.
Cost Comparison	Lower expense ratios due to passive management.	Higher expense ratios to cover active management and operational costs.
Liquidity & Transparency	High liquidity with real-time trading and pricing. Holdings are disclosed daily.	Lower liquidity; transactions happen only once per day at NAV. Holdings are disclosed quarterly.
Tax Efficiency	More tax-efficient due to in-kind creation and redemption, minimizing capital gains tax.	Less tax-efficient as fund managers frequently buy/sell securities, potentially incurring capital gains taxes.

ETFs vs Other Asset Classes

Comparison is often a better way to understand, so let’s see how it does with other asset classes:

Aspect	ETFs	Stocks	Bonds	Real Estate	Commodities
Ownership	Indirect ownership of multiple assets through pooled funds.	Direct ownership in a single company.	Loaning money to an issuer (government/corporate) for fixed interest.	Direct ownership of physical property or through REITs.	Direct ownership of physical commodities or commodity contracts.
Diversification	High — spreads risk across many assets or sectors.	Low — concentrated risk in one company unless diversified manually.	Moderate — depends on bond type, but limited market exposure.	Low — limited to property-specific risk unless diversified across locations or properties.	Low — depends on the specific commodity and its market volatility.
Liquidity	High — traded on exchanges with real-time pricing.	High — liquid stocks trade instantly during market hours.	Moderate — bond markets are less liquid, especially for longer-term bonds.	Low — selling physical property can take time; REIT ETFs improve liquidity.	Varies — precious metals like gold have high liquidity, while some commodities may be harder to trade.
Income Generation	Varies — equity may pay dividends; bond generate interest.	Dividends (if the company pays them).	Regular interest payments.	Rental income or dividends from REITs.	No inherent income; returns rely on price appreciation or trading strategies.
Price Volatility	Moderate — depends on the underlying assets; less volatile than individual stocks.	High — stock prices can swing widely based on company performance and market sentiment.	Low to Moderate — bond prices are generally more stable, but sensitive to interest rate changes.	High — property values fluctuate based on location, economy, and policy changes.	High — commodity prices are highly sensitive to global supply-demand dynamics, geopolitical events, etc.
Capital Requirement	Low — can buy as little as one unit; no minimum investment required.	Varies — depends on the stock price; could be low for smaller companies.	Moderate — bond prices vary, but some bonds require large initial capital.	High — significant capital required to buy property; REITs lower this barrier.	Varies — physical commodities can be expensive; commodity ETFs offer cheaper access.
Tax Efficiency	High — they are tax-efficient due to in-kind transactions reducing capital gains distributions.	Moderate — taxes on dividends and capital gains apply.	Moderate — interest income is taxable, but bond funds may offer some tax advantages.	Low — rental income is taxable, and real estate sales attract capital gains tax.	Moderate — taxes apply on gains, but commodity ETFs may be structured to lower the tax burden.
Management Effort	Low — professionally managed with little investor effort required.	High — requires active research and regular monitoring of individual companies.	Low to Moderate — depends on whether you hold individual bonds or bond ETFs.	High — property management and upkeep required, unless using REIT ETFs.	Moderate — direct ownership may require managing physical assets; commodity ETFs reduce this complexity.

Some Prominent ETFs in India

Below is an overview of some top-performing ones in India:

Name	Symbol	1-Year Return	3-Year Return	5-Year Return
Nippon India – Junior BeES	JUNIORBEES	15.45%	31.14%	125.92%
SBI NIFTY NEXT 50	SETFNN50	16.32%	48.39%	126.35%
KOTAK NV 20	KOTAKNV20	14.58%	48.15%	156.13%
Invesco India NIFTY	IVZINNIFTY	6.86%	31.15%	97.10%
Motilal Oswal M50	MOM50	6.43%	30.56%	98.83%
Quantum Nifty	QNIFTY	7.00%	32.00%	98.10%
Bandhan NIFTY	IDFNIFTYET	7.03%	32.49%	104.19%
SBI NIFTY 50	SETFNIF50	7.38%	32.04%	93.03%
Invesco India Gold	IVZINGOLD	24.12%	58.52%	94.07%
Kotak Nifty Bank	BANKNIFTY1	4.73%	30.02%	52.41%
Nippon India Shariah BeES	SHARIABEEE	5.02%	10.48%	100.26%
SBI 10 YEAR GILT	SETF10GILT	8.63%	17.66%	24.87%
Nippon India Bank BeES	BANKBEES	3.01%	26.06%	52.93%
UTI BSE Sensex	SENSEXETF	7.42%	31.12%	89.17%
CPSE	CPSEETF	20.92%	157.93%	250.17%

Data as of January 30, 2024

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Notable Equity, Bond, and Commodity ETFs:

• Equity: The Nippon India ETF Junior BeES and SBI NIFTY NEXT 50 ETF provide exposure to the Nifty Next 50 Index, encompassing the next tier of large-cap companies beyond the Nifty 50.
• Bond: The SBI 10 YEAR GILT ETF offers investors access to long-term government securities, appealing to those seeking stable returns with lower risk.
• Commodity: For exposure to precious metals, the Invesco India Gold ETF allows investors to participate in gold price movements without the need for physical storage.

Tax Implications in India

Understanding the tax treatment is crucial for investors to make informed decisions. In India, taxation depends on the underlying assets and the holding period.

Taxation Based on Underlying Assets:

• Equity-Oriented ETFs: They invest predominantly in stocks.
  • Short-Term Capital Gains (STCG): If units are sold within 12 months, gains are taxed at 15%.
  • Long-Term Capital Gains (LTCG): For holdings beyond 12 months, gains up to ₹1 lakh are exempt annually. Gains exceeding this threshold are taxed at 10% without indexation benefits.
• Non-Equity-Oriented ETFs: This category invests in debt instruments, gold, or international indices.
  • Short-Term Capital Gains: For units held up to 36 months, gains are added to the investor’s income and taxed as per the applicable slab rate.
  • Long-Term Capital Gains: Holdings beyond 36 months are taxed at 20% with indexation benefits, which adjust the purchase price for inflation, potentially reducing the taxable gain.

Dividend Income from ETFs:

Dividends received are added to the investor’s total income and taxed according to the applicable income tax slab rates. It’s important to note that the Dividend Distribution Tax (DDT) has been abolished, and the onus of tax payment on dividends now lies with the investor.

Pros and Cons of Investing in ETFs

Investors prefer this instrument for the flexibility, cost-effectiveness, and ease of access it offers. However, like all investment options, they have their own set of advantages and disadvantages. Let’s take a pro-con analysis, shall we?

Pros

1. Low Cost and Expense Ratios
   • Unlike mutual funds, ETFs generally have lower expense ratios because most of them follow a passive investing strategy.
   • This means that instead of an active fund manager making decisions, it simply tracks an index, reducing operational costs.
   • For example, Nippon India ETF Nifty BeES has an expense ratio of just 0.05%, much lower than many actively managed mutual funds.
2. Diversification and Risk Reduction
   • It allows investors to diversify their portfolio without purchasing multiple individual stocks or bonds.
   • Investing in a Nifty 50 ETF, for example, provides exposure to 50 of the largest companies in India, reducing the risk associated with holding a single stock.
3. Liquidity and Real-Time Trading
   • Unlike mutual funds, which can only be bought or sold at the end of the day at the Net Asset Value (NAV), ETFs trade like stocks on the exchange.
   • This allows investors to react to market changes instantly and make purchases or sales throughout trading hours.
4. Transparency in Holdings
   • They disclose their holdings daily, ensuring investors always know exactly what assets they own.
   • In contrast, mutual funds generally disclose their portfolio holdings only on a monthly or quarterly basis.
5. Tax Efficiency
   • ETFs, especially equity ones, are more tax-efficient compared to mutual funds.
   • The in-kind creation and redemption process minimizes capital gains taxes for long-term investors.

Cons

1. Market Volatility and Short-Term Risks
   • Since they are traded like stocks, their prices fluctuate throughout the day. This can sometimes lead to short-term volatility, making them risky for inexperienced investors.
2. Tracking Error
   • Some of them fail to perfectly track the performance of their underlying index, leading to minor discrepancies in returns.
   • A high tracking error means the ETF is underperforming compared to its benchmark.
3. Lack of Active Management
   • While passive investing can be beneficial in many cases, some investors prefer the expertise of fund managers who actively adjust portfolios based on market trends.
   • Actively managed mutual funds may outperform ETFs during market downturns due to strategic adjustments.
4. Liquidity Concerns for Low-Volume ETFs
   • Some sectoral and international ETFs in India have low trading volumes, making them less liquid.
   • This can lead to higher bid-ask spreads and potentially impact profitability when buying or selling.

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How to Start Investing in ETFs?

Here’s a step-by-step guide to invest like a pro:

1. Choose the Right one Based on Your Investment Goals

• If you want exposure to the broader market, Nifty 50 ETFs are a good choice.
• If you seek stability and regular income, consider Bonds like SBI 10 Year Gilt ETF.
• For hedging against inflation, Gold ETFs such as Invesco India Gold ETF can be an option.

2. Open a Demat and Trading Account

• Do KYC and open a Demat account and a trading account with a registered broker.
• Popular brokers in India include Zerodha, Groww, Upstox, ICICI Direct, and HDFC Securities.

3. Research and Compare Before Investing

• Use financial websites like NSE India, Moneycontrol, or Value Research to compare ETFs based on:
  • Expense ratios
  • Tracking errors
  • Past performance
  • Asset allocation

4. Place an Order on the Stock Exchange

• They are bought and sold like stocks. Investors can place market orders or limit orders through their brokerage platform.
• It’s best to check their liquidity and trading volume before investing to ensure smooth transactions.

5. Monitor Your Investment Regularly

• Unlike fixed deposits or mutual funds, ETFs require monitoring due to daily price fluctuations.
• Track their performance in relation to its benchmark index to ensure it meets your financial objectives.

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ETFs have become a game-changer in India’s investment landscape. Their low costs, liquidity, transparency, and diversification benefits make them an attractive option for investors of all experience levels. Whether you’re a beginner looking for a passive investment strategy or a seasoned investor seeking to optimize your portfolio, they provide an efficient and flexible investment vehicle.

With India’s market expanding rapidly, now is a great time to explore the potential of exchange-traded products as part of a balanced investment strategy. As always, it’s crucial to research thoroughly, align your investments with your goals, and monitor your portfolio regularly to make the most of your investments.

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FAQs

1. Is it better to invest in ETFs or mutual funds in India?

• It depends on your investment goals. ETFs are cost-efficient and transparent, while mutual funds offer active management and may outperform ETFs in certain market conditions.

2. Can I invest in ETFs with a small amount?

• Yes. You can invest in them for as little as the price of one unit (often ₹50–₹200 per unit). Unlike mutual funds, there is no minimum investment requirement.

3. What are the best to invest in India in 2025?

• Some top-performing ones in India include Nippon India ETF Junior BeES, SBI NIFTY 50 ETF, and Invesco India Gold ETF. However, past performance does not ensure future success.

4. How are they taxed in India?

• Equity: 15% tax for short-term gains (less than 1 year) and 10% for long-term gains above ₹1 lakh.
• Gold & Debt: Short-term gains are taxed as per income tax slab, while long-term gains are taxed at 20% with indexation.

5. Can I do SIP (Systematic Investment Plan) in ETFs?

• Traditional SIPs are not available for them, but some brokers offer ETF-based SIPs where units are bought at fixed intervals in a disciplined manner.