ETFs or Exchange Traded Funds have been gaining popularity in India over the last five years. ETFs offer some advantages over Mutual Funds but also suffer from some limitations:
1. Liquidity: ETFs are bought and sold over a stock Exchange. If a particular ETF is not popular or widely used it may become difficult to sell the units at NAV. The Seller will have to dispose the Units at a discount to the NAV. It is wise to consider liquidity volumes of an ETF before purchase.
2. Demat Account: Investor has to register with a Depository Participant (DP) for maintaining a record of ETF units bought and sold.
3. International Demat Account: While dealing in ETFs registered on international Stock Exchanges the units are held in the Pool Account of the Stock Broker. If the Stock Broking Company winds up or runs into financial trouble, there is a risk to Client’s units held in the Pool Account. This is unlikely though as we can select reputed International Brokers. There is also an Insurance Cover provided by the Broker for value held; however, the enforceability of the Insurance Cover needs to be validated as it is provided by an American Insurer.
4. Dividend’s Taxation: Dividends received by the ETF are taxed as per the laws of the Country in which the Company is listed.
ETFs popularity is growing globally because of low Fund Management Fees, Passive Fund Management, Better performance as compared to Mutual Funds and a more intelligently chosen basket of Stocks (Index). Index Funds overcome some of the limitations of ETFs.
