Investing in a passive product: ETF or index fund?

As you decide to invest in a passive product, you get two options — index funds or Exchange Traded Funds (ETFs). In calendar year 2021, 10 index funds have been launched so far compared to 5 in entire 2020. The number of ETFs stand at 10 in 2021 compared to 15 in 2020.

Index funds and ETFs mirror their underlying benchmark. It means they invest in the same companies that comprise the benchmark index. For example, a Nifty50 index fund or ETF will park money in 50 companies of Nifty50. Similarly, a Sensex index fund or ETF will invest in 30 companies of Sensex.

However, there are some minute differences that you must know.

Cost

The cost of passive products is already cheaper than many other products. However, between an ETF and index fund, ETF will still be cheaper.

Operational difference

An individual needs a demat account to invest in an ETF. Mutual fund investment does not require so. You can start your investment simply by signing up on a platform and doing your KYC.

Real-time NAV versus closing NAV

The net asset value keeps changing in ETF during market hours. You’ll get the real-time NAV when you invest in an ETF. In case of mutual fund, you get the closing NAV of the same day or the next day depending on the time of your transaction during market hours.

Lumpsum vs SIP

Nitin Kabadi, head of ETF Business at ICICI Prudential AMC points out one of the major points of difference.

“For investing in an ETF a demat account is necessary and not all the brokers offer an SIP option for ETF investing. On the other hand, fund houses with index fund offerings offer both SIP and lumpsum options just like any other mutual fund schemes,” he says.

Data shows while index funds are very popular in the largecap category, sectoral passive products are mostly launched in ETF form. So, if you are looking for a sectoral passive product, ETF is the way out.

“According to SEBI guidelines, a sector fund has to invest at least 80% of its assets in a particular sector. As a result, the portfolio will be concentrated in nature which makes it relatively riskier than broad based index funds. Moreover, an investor opting for a sectoral fund has to typically know when to enter and exit a particular sector. Given this requirement, institutional players and HNIs, generally invest in sectoral offerings and since they prefer low-cost products, ETFs are better placed than index funds for them,” says Kabadi.

So far as debt space is concerned, while passive products have made a foray, these are still early days.

“Actively managed debt funds continue to remain popular. Currently, debt ETF is an evolving space with the launch of products such as target maturity debt ETF and Liquid ETF,” says Kabadi.