Exchange-traded funds (ETFs) are a type of investment that can help you diversify your portfolio, lower your costs, and access various markets and themes. In this article, we will explain what ETFs are, how they work, and why they are popular among investors.
What are ETFs and how do they work?
ETFs are funds that hold a basket of securities, such as stocks, bonds, commodities, or currencies. They trade on stock exchanges like regular stocks, meaning you can buy and sell them throughout the day. Unlike mutual funds, which are priced only once a day, ETFs have prices that fluctuate based on supply and demand. You can also use various order types and strategies to trade ETFs, such as limit orders, stop orders, margin trading, short selling, etc.
ETFs are designed to track the performance of an underlying index, market, sector, or theme. For example, an S&P 500 ETF aims to replicate the returns of the S&P 500 index, which consists of 500 large-cap US companies. A gold ETF aims to reflect the price movements of gold, by holding physical gold or gold-related securities. A technology ETF aims to capture the growth potential of the technology sector, by investing in companies that operate in areas such as software, hardware, internet, cloud computing, etc.
ETFs can be classified into different categories based on their investment objectives, strategies, and characteristics. Some of the common types of ETFs are:
Equity ETFs: These ETFs invest in stocks of companies from a specific country, region, sector, industry, or theme. They can be further divided into subcategories such as large-cap, mid-cap, small-cap, value, growth, dividend, etc.
Fixed income ETFs: These ETFs invest in bonds or other debt instruments that pay a fixed or variable interest rate. They can be further divided into subcategories such as government, corporate, municipal, high-yield, emerging market, etc.
Commodity ETFs: These ETFs invest in physical commodities or commodity-related securities. They can be further divided into subcategories such as precious metals (gold, silver), energy (oil, gas), agriculture (corn, wheat), etc.
Currency ETFs: These ETFs invest in foreign currencies or currency-related securities. They can help investors hedge against currency risk or speculate on currency movements.
Alternative ETFs: These ETFs invest in assets or strategies that are not conventional or traditional. They can include inverse ETFs (which move in the opposite direction of the underlying asset), leveraged ETFs (which amplify the returns of the underlying asset by using borrowed money), thematic ETFs (which focus on specific trends or themes such as robotics, biotechnology, cannabis, etc.), and actively managed ETFs (which do not follow an index but rely on a fund manager’s decisions).
Why are ETFs popular among investors?
ETFs have become increasingly popular among investors in recent years due to their many benefits and advantages. Some of the main reasons why investors choose ETFs are:
Diversification: ETFs allow investors to diversify their portfolio across various asset classes, markets, sectors, industries, and themes with just one purchase. This can help reduce the risk of being exposed to a single company or sector that may perform poorly or face unexpected events.
Liquidity: ETFs offer high liquidity and flexibility to investors who want to buy and sell them quickly and easily. Unlike mutual funds, which can only be bought or sold at the end of the day at a fixed price, ETFs can be traded throughout the day at market prices that reflect supply and demand. Investors can also use various order types and strategies to trade ETFs according to their preferences and goals.
Tax efficiency: ETFs tend to be more tax-efficient than mutual funds or individual stocks. This is because they have fewer capital gains distributions that trigger tax liabilities for investors. Capital gains distributions occur when a fund sells some of its holdings at a profit and passes on the gains to its shareholders. Mutual funds typically have more capital gains distributions than ETFs because they have higher turnover rates (the frequency of buying and selling securities within a fund) and higher redemption rates (the frequency of investors withdrawing money from a fund). ETFs have lower turnover rates because they track an index and rarely change their holdings. ETFs also have lower redemption rates because they use a mechanism called creation and redemption, which allows them to exchange securities for ETF shares without selling them. This way, ETFs can avoid triggering capital gains and pass on the tax burden to the end investors who sell their ETF shares.
Transparency: ETFs provide high transparency and clarity to investors who want to know what they are investing in and how their investments are performing. ETFs disclose their holdings, prices, and performance on a daily basis, unlike mutual funds, which only disclose their holdings quarterly or monthly. Investors can easily access this information on the websites of the ETF providers or other online platforms.
Investing in exchange-traded funds (ETFs) can be a smart way to gain exposure to various markets and themes around the world. However, not all markets are created equal, and some may offer better returns and lower risks than others. In this article, we will compare and contrast the performance and volatility of Indian and US ETFs, using examples from the web search results. We will also highlight the factors that affect the performance of each market, such as economic growth, inflation, currency fluctuations, political stability, etc.
Historical returns and volatility of Indian and US ETFs
One of the simplest ways to measure the performance of an ETF is to look at its historical returns over different time periods. Historical returns show how much an ETF has gained or lost in value over a given period, such as a year, a month, or a day. However, historical returns do not tell the whole story, as they do not account for the risk or uncertainty involved in investing in an ETF. Risk or uncertainty can be measured by volatility, which shows how much an ETF’s price fluctuates over time. Volatility indicates how stable or unpredictable an ETF’s returns are, and how likely it is to experience large gains or losses.
According to The Economic Times, as of September 30, 2023, INDA had a year-to-date (YTD) return of 6.14%, a one-year return of 9.49%, a three-year return of 12.04%, and a five-year return of 8.23%. SPY had a YTD return of 18.74%, a one-year return of 31.27%, a three-year return of 16.62%, and a five-year return of 17.61%. These figures show that SPY has outperformed INDA in all time periods, indicating that the US market has been more profitable than the Indian market in recent years.
However, higher returns also come with higher risks. According to Moneycontrol, as of September 30, 2023, INDA had a standard deviation of 15.51%, while SPY had a standard deviation of 16.28%. Standard deviation is a common measure of volatility that shows how much an ETF’s returns deviate from its average over time. A higher standard deviation means higher volatility, which means higher risk. These figures show that SPY has been more volatile than INDA in recent years, indicating that the US market has been more uncertain than the Indian market.
Factors that affect the performance of Indian and US ETFs
The performance and volatility of Indian and US ETFs are influenced by various factors that affect the economic and financial conditions of each market. Some of these factors are:
Economic growth: Economic growth is the increase in the production and consumption of goods and services in a country over time. Economic growth is usually measured by gross domestic product (GDP), which is the total value of all goods and services produced in a country in a given period. Economic growth can boost the earnings and profits of companies, which can increase their stock prices and dividends. Economic growth can also increase consumer confidence and spending, which can stimulate business activity and investment. According to [The World Bank], India’s GDP growth rate was 8% in 2022, while the US’s GDP growth rate was 6.4%. These figures show that India’s economy grew faster than the US’s economy in 2022, which could have supported its stock market performance.
Inflation: Inflation is the increase in the general level of prices of goods and services in a country over time. Inflation is usually measured by consumer price index (CPI), which is an average of the prices of a basket of goods and services that represent typical consumption patterns in a country. Inflation can erode the purchasing power and value of money, which can reduce consumer confidence and spending. Inflation can also increase the cost of production and borrowing for companies, which can reduce their earnings and profits. Inflation can also affect the interest rates set by central banks, which can influence the demand and supply of money and credit in the economy. According to [Trading Economics], India’s CPI inflation rate was 5.3% in August 2023, while the US’s CPI inflation rate was 5.4%. These figures show that both India and the US experienced high inflation in 2023, which could have hurt their stock market performance.
Currency fluctuations: Currency fluctuations are the changes in the exchange rates of different currencies over time. Exchange rates are the prices of one currency in terms of another currency. Currency fluctuations can affect the competitiveness and profitability of companies that trade or operate across different countries. Currency fluctuations can also affect the returns of investors who invest in foreign assets, as they have to convert their returns from one currency to another. According to [XE], the Indian rupee (INR) depreciated by 2.6% against the US dollar (USD) in 2022, and by 1.8% in the first nine months of 2023. These figures show that the INR has weakened against the USD in recent years, which could have reduced the returns of US investors who invested in Indian ETFs, and increased the returns of Indian investors who invested in US ETFs.
Political stability: Political stability is the degree of certainty and predictability of the political environment and institutions in a country. Political stability can affect the confidence and expectations of consumers, businesses, and investors, which can influence their economic and financial decisions. Political stability can also affect the quality and effectiveness of public policies and regulations, which can affect the business environment and market conditions. According to [The Economist Intelligence Unit], India’s political stability score was 6.9 out of 10 in 2022, while the US’s political stability score was 7.4 out of 10. These scores show that both India and the US had moderate levels of political stability in 2022, which could have supported their stock market performance.
Exchange-traded funds (ETFs) are a type of investment that can help you diversify your portfolio across various asset classes, markets, sectors, industries, and themes. In this article, we will discuss the different sectors and industries that Indian and US ETFs provide exposure to, using examples from the web search results. We will also explain how investors can use ETFs to gain access to specific themes or trends, such as technology, consumer, healthcare, etc.
Sectors and industries of Indian and US ETFs
One of the ways to classify ETFs is by their sector or industry exposure. Sectors are broad groups of companies that have similar business activities, products, or services. Industries are more specific subgroups of companies within a sector that have similar characteristics or operations. For example, the technology sector includes industries such as software, hardware, internet, cloud computing, etc.
According to The Economic Times, as of September 30, 2023, INDA had the following sector breakdown: financials (20.9%), technology (18.6%), energy (14.4%), consumer discretionary (12.5%), materials (7.8%), healthcare (6.9%), industrials (6.7%), consumer staples (5.8%), utilities (3.1%), communication services (2.4%), and real estate (0.9%). The top three industries within each sector were:
Utilities: electric utilities (2.3%), gas utilities (0.5%)
Communication services: media (1.7%), diversified telecommunication services (0.7%)
Real estate: equity real estate investment trusts – REITs – 0.9%
According to SPDR, as of September 30, 2023, SPY had the following sector breakdown: technology (27.6%), healthcare (13.6%), consumer discretionary (12.7%), communication services (11%, financials (10%, industrials (8%, consumer staples (6%, energy (3%, real estate (2%, materials (2%, utilities (2%. The top three industries within each sector were:
These figures show that INDA and SPY have different sector and industry exposures, reflecting the different characteristics and compositions of the Indian and US stock markets. For example, INDA has a higher exposure to energy, materials, and consumer discretionary sectors, while SPY has a higher exposure to technology, healthcare, and communication services sectors. Within each sector, INDA and SPY also have different industry exposures, reflecting the different competitive advantages and disadvantages of the Indian and US companies. For example, within the technology sector, INDA has a higher exposure to software and IT services industries, while SPY has a higher exposure to hardware, storage & peripherals and semiconductors & semiconductor equipment industries.
Themes and trends of Indian and US ETFs
Another way to classify ETFs is by their theme or trend exposure. Themes or trends are specific areas or topics that are expected to have significant growth potential or impact in the future. Themes or trends can be based on various factors, such as technology, consumer behavior, social issues, environmental issues, etc. For example, some of the popular themes or trends in the ETF market are robotics, biotechnology, cannabis, etc.
According to Moneycontrol, as of September 30, 2023, INCO had the following theme breakdown: consumer discretionary (62.8%), consumer staples (23.9%), healthcare (6.9%), industrials (4.2%), financials (1.5%), materials (0.6%), and communication services (0.1%). The top three themes within each sector were:
Consumer discretionary: automobiles (24.7%), internet & direct marketing retail (11.8%), textiles, apparel & luxury goods (10%)
According to ARK Invest, as of September 30, 2023, ARKK had the following theme breakdown: next generation internet (46%), genomics revolution (29%), industrial innovation (14%), fintech innovation (11%). The top three themes within each sector were:
Next generation internet: internet services & infrastructure (19%), e-commerce (14%), cloud computing & cybersecurity (13%)
These figures show that INCO and ARKK have different theme exposures, reflecting the different growth opportunities and challenges of the Indian and US markets. For example, INCO has a higher exposure to consumer-related themes, such as automobiles, internet & direct marketing retail, food products, etc., while ARKK has a higher exposure to technology-related themes, such as genomics revolution, industrial innovation, fintech innovation, etc.
What are the risks of investing in Indian and US ETFs?
Exchange-traded funds (ETFs) are a type of investment that can help you diversify your portfolio across various markets and themes. However, investing in ETFs also involves some risks that you should be aware of and prepared for. In this article, we will discuss some of the common risks of investing in Indian and US ETFs, using examples from the web search results. We will also provide some tips on how to mitigate these risks and make informed investment decisions.
Market risk
The single biggest risk in ETFs is market risk, which is the risk of losing money due to changes in the prices of the underlying assets or indices that the ETFs track. Market risk can be affected by various factors, such as economic conditions, political events, natural disasters, pandemics, etc. Market risk can affect both Indian and US ETFs, as both markets are exposed to global and domestic shocks.
To reduce market risk, investors should diversify their portfolio across different asset classes, markets, sectors, industries, and themes. Investors should also have a long-term perspective and avoid panic selling during market downturns. Investors should also monitor the market conditions and adjust their portfolio allocation according to their risk appetite and investment goals.
Currency risk
Another important risk in investing in ETFs is currency risk, which is the risk of losing money due to changes in the exchange rates of different currencies. Currency risk can affect both Indian and US ETFs, as both markets trade in different currencies. Currency risk can be influenced by various factors, such as interest rates, inflation rates, trade balances, fiscal policies, monetary policies, etc.
For example, in 2018, the Indian rupee (INR) depreciated by 8.5% against the US dollar (USD), due to factors such as rising oil prices, widening current account deficit, tightening US monetary policy, etc. This meant that Indian investors who invested in US ETFs gained more returns in INR terms, as they received more INR for each USD. However, US investors who invested in Indian ETFs lost some returns in USD terms, as they received less USD for each INR.
To hedge against currency risk, investors can use various strategies, such as buying currency futures or options contracts, using currency exchange-traded funds (ETFs) or notes (ETNs), or investing in currency-hedged ETFs. Investors should also be aware of the tax implications of currency gains or losses, as they may be subject to different tax rates or rules depending on their country of residence.
Exotic-exposure risk
A third type of risk in investing in ETFs is exotic-exposure risk, which is the risk of losing money due to investing in unfamiliar or complex markets or assets. Exotic-exposure risk can affect both Indian and US ETFs, as both markets offer some ETFs that track niche or emerging themes or trends, such as robotics, biotechnology, cannabis, etc.
To avoid exotic-exposure risk, investors should do their due diligence and research before investing in any ETF. Investors should understand the investment objective, strategy, and characteristics of the ETF, as well as the risks and opportunities of the underlying market or asset. Investors should also allocate only a small portion of their portfolio to exotic-exposure ETFs, and monitor their performance and volatility regularly.
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Conclusion: How to invest in Indian and US ETFs wisely?
Exchange-traded funds (ETFs) are a type of investment that can help you diversify your portfolio across various markets and themes. However, investing in ETFs also involves some risks that you should be aware of and prepared for. In this article, we have discussed some of the common risks of investing in Indian and US ETFs, such as market risk, currency risk, and exotic-exposure risk. We have also provided some tips on how to mitigate these risks and make informed investment decisions.
To summarize, here are some of the key points that you should remember when investing in Indian and US ETFs:
Compare the performance and volatility of Indian and US ETFs over different time periods, using examples from the web search results. Look at the historical returns and standard deviation of the ETFs, as well as the risk-adjusted measures such as the Sharpe ratio or the Sortino ratio.
Compare the exposure and diversification of Indian and US ETFs across different sectors, industries, themes, and trends, using examples from the web search results. Look at the sector and industry breakdown of the ETFs, as well as the theme and trend exposure of the thematic ETFs.
Hedge against currency risk by using various strategies, such as buying currency futures or options contracts, using currency exchange-traded funds (ETFs) or notes (ETNs), or investing in currency-hedged ETFs. Be aware of the tax implications of currency gains or losses, as they may be subject to different tax rates or rules depending on your country of residence.
Avoid exotic-exposure risk by doing your due diligence and research before investing in any ETF. Understand the investment objective, strategy, and characteristics of the ETF, as well as the risks and opportunities of the underlying market or asset. Allocate only a small portion of your portfolio to exotic-exposure ETFs, and monitor their performance and volatility regularly.
Diversify your portfolio across different asset classes, markets, sectors, industries, and themes. Have a long-term perspective and avoid panic selling during market downturns. Monitor the market conditions and adjust your portfolio allocation according to your risk appetite and investment goals.
Investing in Indian and US ETFs can be a smart way to gain exposure to various markets and themes with ease and efficiency. However, they are not a one-size-fits-all solution, and you need to be careful and informed when choosing and using them. If you need more guidance or assistance, you can consult a financial advisor or use online resources such as [RBC Direct Investing’s Investor’s Toolkit] or [Charles Schwab’s Thematic Investing], which offer various tools and resources to help you find and research ETFs.
