What if you could invest in gold, the Nifty 50, or even an entire sector, all at the cost of a cup of coffee? That’s the charm of ETFs. They trade like stocks, offer diversification like mutual funds, and come with ultra-low costs. But while they look simple on the surface, there is a strong ecosystem working behind the scenes to keep everything running smoothly.
Curious to know how it all fits together? Let us break down the ecosystem that powers these quiet performers of the investment world.
What is an ETF?
An ETF (Exchange-Traded Fund) is an investment fund that tracks an index, commodity, or asset and is traded on stock exchanges like a stock. It offers the benefits of diversification, low cost, and real-time trading. ETFs are especially popular among investors seeking exposure to broader markets or specific themes without actively picking individual stocks.
How do ETFs work?
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Ecosystem of ETFs
1. AMC (Asset Management Company)
The AMC is the brain behind the ETF. It designs the ETF product (e.g., Nifty 50 ETF, Gold ETF), creates ETF units, manages the portfolio in line with the index, and declares the iNAV (Indicative Net Asset Value) daily.
2. Authorised Participants (APs)
APs are large institutional players, such as banks and brokers, who act as intermediaries between the AMC and the market. They deliver a basket of securities (e.g., Nifty 50 stocks) to the AMC and receive ETF units in return.
3. Custodian
Think of the custodian as a secure vault. It holds the actual underlying securities of the ETF, whether stocks, gold, or others. In India, custodians could include SBI-SG Global, HDFC Bank, etc. They ensure:
The ETF is backed by real assets.
In case of heavy selling, Authorised Participants can redeem ETF units with the AMC in exchange for the underlying basket of securities. The custodian facilitates settlement since it holds the ETF’s underlying assets on behalf of the fund.
4. Market Makers
Often the same as APs, market makers provide liquidity by placing continuous buy/sell quotes on the exchange. They help keep ETF prices aligned with NAV through arbitrage. Without them, ETFs may become mispriced or illiquid.
5. Management Fee (Expense Ratio)
ETFs in India typically charge between 0.05% to 0.30% as a management fee. This fee is deducted from the NAV daily, you don’t pay it separately. Compared to mutual funds, which may charge up to 2%, ETFs are ultra-cheap.
Buying & Selling ETFs
Investors with a trading account (e.g., with CubePlus) can buy and sell Gold ETF units on stock exchanges. These units are credited to their demat account as per the prevailing settlement cycle of the exchange, just like shares.
Prices move in real time, based on global gold prices and demand-supply dynamics on the exchange.
No physical delivery is involved; everything is digital.
How is the market price determined?
The price of 1 unit of Nippon India Gold ETF:
Each Gold ETF unit represents a specified quantity of gold, defined in the scheme documents, and typically reflects fractional ownership of physical gold held by the fund.
Moves in sync with international gold prices, the INR/USD exchange rate, and local supply and demand.
May carry a small premium or discount to NAV due to market fluctuations.
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Gold ETF vs Tanishq Gold coins (4 grams)
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India offers a wide range of ETFs, including sector-specific and commodity ETFs like the SBI ETF Nifty Bank and the ICICI Prudential Gold ETF.
The ETF Comparison Table
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ETF prices generally move in line with their underlying index.
For example, ETF prices generally move proportionately to changes in the underlying index, subject to expense adjustments and minor tracking differences.
In March 2020, NiftyBeES was ₹88 when the Nifty was 8,000. Now, with Nifty at 24,800, it’s at ₹277.
Some ETFs, like PharmaBeES, trade at low prices (₹23), making them accessible even for small-ticket investors.
Not just a fancy ticker
ETFs are a powerful tool for the modern investor, combining the diversification of mutual funds with the flexibility of stocks. However, they are not for everyone. If you prefer simplicity and don’t want to open a demat account, mutual funds or index funds are still great options.
