Investing in exchange-traded funds

ETFs are much in demand globally due to ease of pouring money into these funds


Karachi December 13, 2020

If you are someone who is new to investing or has little to no knowledge of the stock market, then you need an investment instrument which is in line with your risk and return objectives.

If you don’t have time to research, understand stocks, identify particular scrips, keep track of dividends or coupons and capital gains, then Exchange-Traded Funds (ETFs) are the right instrument of investment for you.

At the same time, if you want to save money by not investing in each and every stock individually or avoid paying higher management fee (as in mutual funds), then ETF is indeed the way forward for you.

Internationally, ETFs are much in demand because of the inherent ease of investing in these funds. While ETFs may be a cost-effective and attractive investment avenue, investors are advised to get informed about the inherent risks involved in investing in stocks and securities such as ETFs.

Now the question is, what is an ETF? ETF is a kind of security that constitutes a collection of securities – such as stocks – which tracks an underlying index. Because ETFs (composed of stocks) constitute a diversified group of stocks, the diversification benefit from investing in these instruments can be enjoyed by investors.

However, it is important to mention that ETFs are not devoid of the inherent risks in the market. ETFs can be composed of stocks from different sectors and industries or from a single industry. ETFs may constitute one category of stocks or different ones. ETFs track underlying specific benchmark indices. Hence, ETFs are (generally) passive funds. When someone buys units of an ETF, he/ she is buying shares of a portfolio that tracks the yield and return of its index.

ETFs trade at a price close to their underlying basket price. However, because of demand/ supply forces in the market, there are times when the ETF will trade at a discount or premium to its net asset value (NAV) – assets minus liabilities on a per unit basis.

NAV of an ETF is calculated by the ETF fund manager at the close of trading day for investors to gauge the underlying value of their holdings.

On the other hand, the indicative NAV (iNAV) is available at different periods of time during trading hours to help investors make right decision on investing in ETFs.

ETFs vs mutual funds

You may feel confused between ETFs and mutual funds because of their similarities. However, while there are similarities, ETFs are a different product altogether.

Unlike mutual funds, ETFs have the liquidity and trading flexibility of stocks. ETFs can be bought and sold anytime during trading hours like stocks and shares. On the other hand, mutual funds are purchased or redeemed based on the end-of-day NAV.

Also, the underlying stocks constituting the ETF are disclosed every trading day whereas in mutual funds they are disclosed monthly by their respective asset management companies (AMCs).

In terms of fee and charges, ETFs have a lower management fee as compared to mutual funds, which have a higher management fee and have a sales load/ sales charge as well. However, broker’s commission is charged on ETF trades. There are many advantages of investing in ETFs. ETFs are easy to invest in. They can be bought and sold on the stock market through a brokerage account.

For investing in ETFs, a brokerage account with a PSX Trading Right Entitlement Certificate (TREC) holder or brokerage firm needs to be opened. Orders to purchase and sell ETFs can be placed just like for shares’ purchase and sale. Limit orders and stop orders are also possible in ETFs.

ETFs provide an easy way to diversify across different sectors, industries or securities, and can constitute stocks, commodities, bonds, or other securities. In many markets of the world, there are several types of ETFs on offer, which are composed of a combination of securities varying across different asset classes.

ETFs around the world

ETFs are a popular investment instrument in many countries around the world. More than 50 countries have ETFs listed on their markets. ETFs can boast of assets under management of more than $7 trillion globally, as of September 2020, according to the Financial Times.

In Pakistan, at present, there are four ETFs listed on the exchange. These are NIT Pakistan Gateway ETF offered by NIT, UBL Pakistan Enterprise ETF offered by UBL Fund Managers Limited, Meezan Pakistan ETF offered by Al Meezan Investment Management Limited and NBP Pakistan Growth ETF offered by NBP Fund Management Limited.

While we have a few ETFs of the conventional type, there is also a Shariah-compliant ETF (Meezan Pakistan ETF) available to those investors who want to invest according to Islamic principles of finance. It is expected that more such instruments will be listed on Pakistan Stock Exchange with the passage of time. Conclusively, we can say that the ETF is a complete package of an investment instrument, addressing your concerns as an investor from all aspects, may it be ease of account opening, transparency with regard to underlying stocks, periodic announcement of iNAV, cost effectiveness and diversification.

The writer is the Head of Marketing & Business Development at Pakistan Stock Exchange

 

Published in The Express Tribune, December 14th, 2020.

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