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Available since 1993 in U.S. and 1999 in Europe, Exchange Traded Fund (ETF) is a marketable
security, that tracks a stock index, a commodity, bonds or a basket of assets. It generally operates
with an investing mechanism designed to keep it switching close to its net asset value. When you
invest in ETFs, your money is spent in a bunch of market securities which are a part of an
established index. Just like the name suggests, ETFs are exchange-traded which means that you
can buy and sell them at any time of the day when the markets are open.
The supply of ETF shares is regulated through a mechanism called Creation and Redemption,
which involves large specialized investors called Authorized Participants.ETF distributor only buys
or sell ETFs from directly from or to authorized participants, i.e. the large broker-dealers with
whom they have made an agreement. Authorized participants may wish to invest in the ETF
shares for long-term, but they usually act as market makers on the open market.
An authorized participant can regain ETF shares by selling them back to the fund’s sponsor.
Selling assets to the ETF sponsor, in return for stocks in ETF is known as Creation. A redemption
mechanism refers to how the market makers of ETF help to coordinate the differences between
net asset value and market values.
While most ETFs track stock indexes, there are also ETFs that invest in commodity markets,
currencies, bonds, and other asset classes. Many ETFs also have an option available for investors
to use income, belief or surrounding strategies.
NASDAQ ETF by Motilal Oswal which tracks the NASDAQ index of USA
HANGSENG BEES by Reliance Nippon which tracks HANGSENG stock index of HongKong
4. Sector Specific ETF: Investors who want to invest in a specific sector opt for this ETF. These
utilize the performance of the industry as a tracking instrument. Depending on the industry you
choose to spend, you will see the value of ETF ranging by the performance of the selected sector.
Example –
A portfolio made up of all Sensex discards since November 2007 generated an annualized return
of 13.8% , while in the case of Nifty, the discards together generated returns of 11.5% annually.
In contrast, the portfolio of stocks added to the Sensex returned a much lower 6.2 %. With the
Nifty, a collection of stocks that were included generated annualized returns of 8%.
Sensex and Nifty follow a pattern of investing, where stocks that have done well in the recent
past are included in the index, while inactive are dropped. As a result, additions are of higher
value.
The Sensex and nifty returned 10.7% annually, using the strategy where an equal amount is
invested in these indices. Sensex/Nifty returns assume investments on the same date as the date
of inclusions/exclusions.