Are all ETFs same for investment?

Generally whenever one mentions Exchange Traded Funds (ETFs), people assume it to be a replica of the index, which in Indian scenario means the replica of Sensex or Nifty. However, it may not always be true. There are ETFs which track the subset of the index or a particular sector (eg. Banks) or even a commodity (eg. Gold). This post will guide you to understand ETFs and how to choose one.

ETFs available for investments:

One can invest in any of the following ETFs (I have chosen only those ETFs which are more than one year old):

Schemes	Asset Size (Rs. Cr)	1 Yr Returns	3 Yr Returns	Expense Ratio
Nifty ETFs
Nifty BeES	400	21.3	5.7	0.5
ICICI Pru SPIcE Plan	1	19.7	5.5	0.8
Kotak Sensex ETF	21	20.0	n.a.	0.5
Nifty Junior ETFs
Nifty Junior BeES	185	34.1	13.0	0.5
Banks ETFs
Nifty Bank Benchmark	19	28.5	16.9	0.5
Bank BeES	39	29.3	19.0	0.5
Reliance Banking ETF	15	29.0	n.a.	0.35
Kotak PSU Bank ETF	16	38.1	n.a.	0.65
PSU Bank BeES	7	37.9	n.a.	0.75
Gold ETFs
UTI Gold Exchange Traded Fund	390	20.4	23.7	1.0
Reliance Gold ETF	321	23.2	n.a.	1.0
Gold BeES	1244	20.3	23.8	1.0
Kotak Gold ETF	167	20.3	23.7	1.0
Quantum Gold Fund	24	20.3	n.a.	1.0
SBI Gold Exchange Traded Fund	139	20.9	n.a.	1.7

n.a. - not available

Returns as of 22nd October 2010

When to invest in ETFs?

Equity ETFs are good in diversifying your investments, similar to mutual funds. However, they generally track the benchmark in which they invest and can not give superior returns as compared to the benchmark. Whereas, mutual funds are managed actively and in countries like India, are able to generate additional returns. Diversified equity mutual fund should ideally form one’s core equity holding and equity ETFs should supplement this investment. However, in case one is not comfortable in trusting fund manager’s performance, he can invest more in ETFs.

What to look for in ETFs before investing?

1. First you should determine the type of exposure you would like to have through ETFs. In case you want the exposure to index stocks, good way to invest will be through ETFs like NIFTY BeES. If you want exposure to mid cap stocks along with large cap stocks, you can invest in Nifty Junior BeES. Similarly, in case you want to invest in Gold, you can look at Gold ETFs.

2. Second thing you need to do is compare the ETF returns with the benchmark. Your reason for investment in ETF is to ensure that you get returns similar to benchmark return. Hence, you should be wary of ETFs which consistently is above or below benchmark by significant percentage (more than 1% in this case). Tabulated below is the comparison of Index ETFs with the Nifty benchmark which is 20.5% for 1 year and 5.6% for 3 years. You can notice that generally they track the benchmark which is a positive sign (i.e. their tracking error is low). 

Similar analysis for Gold ETFs.

3. Next thing to check is the fund size. Greater the fund size, more comfortable you should be. Nifty BeES has the fund size of Rs. 400 crores as against Rs. 21 crores for Kotak Sensex ETF.

4. Last thing to check is the annual expenses which the fund house incurs to generate returns. Lower the expenses, better the returns. Hence look out for ETFs with less expense ratio. Nifty BeES and Kotak Sensex ETF have expense ratio of 0.5% p.a. where as ICICI Pru SpicE Plan has expense ratio of 0.8% p.a.

Keep these points in mind and start investing in ETFs.  Bachhat prefers Nifty BeES for exposure to index stocks, Junior BeES for mid cap stocks and Gold BeES for investment in gold.

As usual, comments appreciated.