Passively managed mutual funds are represented through Exchange Traded Funds (ETFs). These funds invest into an underlying asset or portfolio of assets and trade on stock exchanges. The underlying asset portfolio may represent an index, securities, commodities, bonds or currencies. 

An ETF passively tracks an index like the Sensex and Nifty. It does this by holding securities in the same weights as the Sensex / Nifty.  You need a Demat and Trading Account to invest in an ETF. The same Demat and Trading Account can also be used for buying and selling direct stocks.

Index ETFs:

Popular Index ETFs are Reliance ETF Nifty BeES,  ICICI Prudential Sensex iWIN ETF,  Motilal Oswal MOSt shares Midcap 100 ETF,  Motilal Oswal MOSt shares M50 ETF etc.

Gold ETFs:

Reliance ETF Gold BeES,  SBI Gold ETF,  Birla Sunlife Gold ETF and UTI Gold ETF are some of popular Gold ETFs.

Bond ETFs:

Reliance ETF Bank BeES, SBI ETF 10 year Gilt are some of Bond ETFs.

Currency ETFs:

Wisdom Tree Indian Rupee Strategy Fund, Market Vectors Indian Rupee/USD ETF are some of Currency ETFs.

Global Index ETFs:

Reliance ETF Hang Seng BeES and MOSt shares NASDAQ 100 ETF are Global Index ETFs.

Advantages of ETFs

Low Cost

The foremost advantage of investing in an ETF is its low expense ratio, which is usually less than 0.5% compared to about 2% expense ratio for an actively managed mutual fund.

Liquid

Since an ETF can be bought and sold on any trading day on stock exchanges, it is more liquid than a regular mutual fund. 

Transparency 

Since an ETF tracks an index, you know beforehand in which stocks it will invest and in what proportion. For example, the Nifty 50 is composed of the 50 largest listed companies in India by market capitalization. An ETF tracking the Nifty 50 will hold the same companies and in the same weights as in Nifty. 

No judgment Error by Fund Manager 

Since an ETF tracks an Index, it does not rely on active investment calls by a fund manager. Hence it is not affected by a fund manager’s judgment errors. It can sometimes have an error in tracking the index (called tracking error), but this is usually small in magnitude.

Diverse Products

ETFs in India track diverse products like Nifty, Gold, Nifty Next 50, Bonds and some global indices. You can select / invest in an ETF  as per your choice of asset class for investment.

Limitations of ETFs

Giving up Alpha

An ETF investor is giving up the potential to outperform (called Alpha) since he has invested only in a passively tracking mutual fund. On the other hand, an actively managed mutual fund can not only give you the index return but also beat it by generating Alpha.

Large companies and moderate returns only

Usually large and mature companies only make it to indices like the Nifty or Sensex. Such indices only include the largest companies by size and many of these companies have put their best years of growth behind them. Such large shares are generally fully priced and hence can give only moderate returns. On the other hand, one can opt to invest in mid cap stocks or in emerging blue chip stocks through actively managed mutual funds, to target higher returns.

Best performing ETFs

1) Reliance ETF Bank BeES ETF tracking Bank Nifty (banking stocks) has generated a 3 year CAGR of 22.09%.

2) Motilal Oswal Nasdaq 100 ETF tracking the Stocks listed in the Nasdaq (US tech companies) has generated a 3 year CAGR of 16.49%.

3) Reliance ETF Nifty BeES ETF tracking Nifty 50 shares has generated a 3 year CAGR of 14.81%.

4) Motilal Oswal Midcap 100 ETF tracking Midcap stocks has generated a 3 year CAGR of 12.10%.