ETF – Exchange traded fund example

In this article, I’ll be explaining an example of ETF or Exchange Traded Fund – which is requested by some of the readers. As again, though it will be early for me to introduce another efficient investment strategy, I will attempt to highlight a few practical example of ETF which are trading in the market for some time.

Continuing with the article: How are these ETF’s created, issued and redeemed by the investors. Here’s what goes on:

As we all know that ETF is based on an index – like Dow Jones, Nifty or Sensex. ETFs are a bit different from Mutual funds in the sense that ETF units are not sold to the public for cash. Instead, the Asset Management Company (Say UTI or Franklin Templeton) that sponsors the ETF (Fund) takes the shares of companies comprising the index from various categories of investors like authorized participants, large investors and institutions. In turn, it issues them a large block of ETF units. Since dividend may have accumulated for the stocks at any point in time, a cash component to that extent is also taken from such investors. In other words, a large block of ETF units called a "Creation Unit" is exchanged for a "Portfolio Deposit" of stocks and "Cash Component".

Some investors may prefer to hold the creation units in their portfolios. While others may break-up the creation units and sell on the exchanges, where individual investors may purchase them just like any other shares.

ETF units are continuously created and redeemed based on investor demand. Investors may use ETFs for investment, trading or arbitrage. The price of the ETF tracks the value of the underlying index. This provides an opportunity to investors to compare the value of underlying index against the price of the ETF units prevailing on the Exchange.

Now, let’s look at an ETF or Exchange Traded fund called – NIFTYBees. This ETF is available for trading on NSE since 8-Jan-2002. On the issue day, the opening price of this particular ETF was 120 Rs, while it closed at 111.55 Rs. Yesterday, on 19^th July 2007, the closing price of this NiftyBees ETF stock was 460 Rs. In terms of the percentage gains:

(460-111.55)
------------------	*100	=	312.37%
111.55

The Nifty Index, had a closing value of 1109.9 on 8-Jan-2002; while yesterday, 19^th July 2007, it closed at 4562. The percentage gains for Nifty (underlying Index) has been:

(4562-1109.9)
------------------	*100	=	311.03%
1109.9

Compare the returns from Nifty Index (311.03%) to that of those from NiftyBees ETF (312.37%). They are almost exactly the same - with hardly any difference. Moreover, due to the trading activities, it is possible to get a higher value for ETF during the day as the trading proceeds. If you had bought this NiftyBees ETF on 8-Jan-2002 by investing say 1 Lakh Rs., your investment would have grown to a total of 412,371 Rs., giving you a clear cut net profit of 3.12 Lakh Rs. that too in just over 4 years time. It translates to an simple average return of 312/4.5 = 70% return for each individual year.

You would have hardly paid a maximum of 1% brokerage on buying the ETF and another 1% on selling the ETF. That will hardly make any significant difference to your profits.

Which Insurance policy or mutual fund or your own stock picking skills would have given you such staggering returns. I see ads in newspapers – XYZ mutual fund returns 80% in just one year! – what happens the next year? The same mutual fund is not able to keep up its performance – so no ads in the next year claiming excellent profit. Ads that are posted will only be for promotion of mutual fund, not for claiming good returns.

Which Insurance policy, clubbed with returns would have given you such returns – atleast I don’t know of any.

How have your own stock picking skills figured? Were you able to get the same level of profits on your individual investment?

What’s the cost that you pay to trade in ETFs? Hardly a maximum of 2% - 1% on buying, another on selling. Hold them for long term and tax you pay on these will be zero.

I’ve already proven in my previous article

explaining efiicient market hypothesis, that it is impossible for anyone to beat the market consistently year after year. The best you can do is to carry on and go with it, attempting to match the performance of the market. ETFs do exactly that.

Then there are others who say that by investing in so called bluechip companies or top level index based ETFs, we loose on the mid-caps which can outperform the market. For such investors, there is JUNIORBees – a midcap based ETF based on Nifty Junior (comprising of top 51 to 100 stocks).

Have a look at the closing prices of JuniorBees on 11-Feb-04, it was 34 Rs. While yesterday, it was 92.5. The percentage increase has been 172.06% over the period.

While for the same period, Nifty itself has closing value of 1891 on 11-Feb-04 and 4562 yesterday. The percentage gain is 141.25%. Here the Junior ETF has outperformed the main market index by more than 30%.

One thing to note here is that all the ETFs started in India after 2001 period. This was the period where the Indian Markets have seen a major Bull run and hardly very short periods of bear markets. However, the ETFs have been proven to be the most efficient instruments as I’ve explained in the table presented in my previous article

http://invest-n-trade.blogspot.com/2007/07/index-funds-vs-exchange-traded.html> Index Fund v/s Exchange Traded Funds, What’s good Whats Bad?. The best part of ETFs is that you always go with the market.

There was a demand from some readers about a practical example of an Indian ETF. I guess the data presented above should be sufficient to make them understand the working of ETF and it’s efficiency. Readers who may like to verify the data presented here can do so by downloading the data from Yahoo finance or exchange websites. You can expect the same easy-2-understand articles, similar to the once I’ve posted for introducing ETFs and IFs for http://invest-n-trade.blogspot.com/2007/06/simplest-investment-strategy.html The Simplest Investment Strategy.