What are ETFs? A Complete Guide to Exchange Traded Funds in India

Exchange Traded Funds (ETFs) have emerged as one of the fastest-growing investment products in India. As of March 2025, ETFs held approximately Rs 8.39 lakh crore in Assets Under Management, constituting about 13% of the total Indian mutual fund industry. But what exactly are ETFs, and why are they gaining such popularity?

What is an ETF?

An ETF (Exchange Traded Fund) is a basket of assets that trades on a stock exchange, much like an individual stock does. These baskets may track a wide range of indices or commodities such as the Nifty 50, Sensex, Gold, Silver, or specific sectors.

Key characteristics:

• Trades like a stock - You can buy and sell ETFs during market hours at real-time prices
• Tracks an index - Most ETFs passively replicate the performance of a specific benchmark
• Lower costs - Due to passive management, ETFs typically have lower expense ratios
• Transparent holdings - ETF holdings are disclosed daily

How Do ETFs Work?

When you buy an ETF, you're essentially buying a small piece of a diversified portfolio. For example, one unit of a Nifty 50 ETF gives you exposure to all 50 companies in the Nifty index in the same proportion as the index itself.

The mechanics:

1. The ETF provider (AMC) creates the fund by buying the underlying assets
2. Units are issued and listed on stock exchanges (NSE/BSE)
3. Investors buy and sell units through their trading accounts
4. Prices fluctuate throughout the day based on supply and demand
5. The ETF price closely tracks the Net Asset Value (NAV) of underlying assets

Types of ETFs in India

ETFs in India can be broadly categorized into six types:

1. Index ETFs

Track major indices like Nifty 50, Sensex, Nifty Next 50, or Nifty Bank. These are the most popular ETFs for investors seeking broad market exposure.

2. Gold ETFs

One unit of a Gold ETF is backed by one gram of physical gold with 99.5% purity. They offer a convenient way to invest in gold without physical storage concerns.

3. Sector ETFs

Focus on specific sectors like IT, Banking, Pharma, or Infrastructure. Useful for investors with sector-specific views.

4. Bond ETFs

Invest in government securities or corporate bonds. These provide fixed-income exposure with the liquidity of equity trading.

5. Currency ETFs

Track currency movements, useful for hedging currency exposure or speculating on forex movements.

6. Global/International ETFs

Provide exposure to international markets like the US (Nasdaq 100, S&P 500) or other global indices.

ETFs vs Mutual Funds: Key Differences

Benefits of Investing in ETFs

1. Low Cost

ETFs typically have expense ratios of 0.05% to 0.5%, significantly lower than actively managed mutual funds. Over long periods, this cost difference can substantially impact your returns.

2. Instant Diversification

A single ETF unit gives you exposure to an entire index or sector, providing instant diversification without buying individual stocks.

3. Flexibility

Unlike mutual funds priced once daily, you can trade ETFs throughout market hours at real-time prices. This is useful if you want to enter or exit at specific price points.

4. Transparency

ETF holdings are disclosed daily, so you always know exactly what you own. This transparency helps in making informed investment decisions.

5. No Fund Manager Risk

Since most ETFs passively track an index, there's no risk of a fund manager's poor decisions affecting your returns.

Considerations Before Investing

1. Demat Account Required

Unlike mutual funds, you need a demat and trading account to invest in ETFs. This additional requirement might be a barrier for some investors.

2. Liquidity Concerns

Some ETFs, especially sectoral or thematic ones, may have low trading volumes. This can lead to wider bid-ask spreads and difficulty in executing large orders.

3. Tracking Error

ETFs aim to replicate index returns, but there's always a small difference (tracking error) between ETF returns and actual index returns due to expenses and cash holdings.

4. No SIP Convenience

While some brokers offer ETF SIPs, the infrastructure isn't as robust as mutual fund SIPs. Manual buying during market hours might be required.

Taxation of ETFs (2025-26)

Equity ETFs (Index ETFs, Sector ETFs)

• STCG (held less than 12 months) - Taxed at 20%
• LTCG (held more than 12 months) - Tax-free up to Rs 1.25 lakh; 12.5% on gains above this limit

Gold ETFs

• STCG (held less than 12 months) - Taxed as per income slab
• LTCG (held more than 12 months) - Taxed at 12.5% without indexation (post April 2025)

How to Invest in ETFs

1. Open a demat and trading account with a broker (Zerodha, Groww, ICICI Direct, etc.)
2. Research the ETF - Check expense ratio, tracking error, trading volume, and AUM
3. Place a buy order - Search for the ETF by name or symbol and place a market or limit order
4. Monitor and rebalance - Periodically review your ETF holdings and rebalance if needed

ETF Growth in India

The Indian ETF market has seen remarkable growth:

• ETF AUM grew by 5.5x over the last 5 years (March 2020 to March 2025)
• Retail investor folios in ETFs reached 2.63 crore as of March 2025, up from 23.22 lakh in March 2020
• ETFs now constitute about 13% of India's total mutual fund industry AUM

Leverage Your ETF Holdings with DhanLAP

Your ETF investments represent real value that can work harder for you. At DhanLAP, we offer Loan Against Mutual Funds (LAMF) that can include your ETF holdings. This means:

• Access liquidity without selling - Keep your ETF portfolio intact
• Continue earning returns - Your ETFs keep tracking the market while pledged
• Avoid capital gains tax - No redemption means no tax liability
• Quick processing - Get funds when you need them

Final Thoughts

ETFs offer a cost-effective, transparent, and flexible way to invest in markets. They're particularly suitable for investors who want index-linked returns without paying for active management, have a demat account, and are comfortable with market-hour trading.

For beginners, starting with broad market ETFs like Nifty 50 or Sensex ETFs provides excellent diversified exposure to the Indian equity market at minimal cost.