An exchange traded fund (ETF) is a mutual fund scheme whose units are listed on a stock exchange, so investors buy and sell them through a demat and trading account at a live market price. It is built to follow an index or an underlying asset such as gold, and it is not managed to beat it.
For those asking what is an ETF, the SEBI is the statutory regulator of India's securities market, with the legal duty to protect investors and to promote and regulate that market. Read the full meaning of SEBI approved scheme documents treat it as a mutual fund scheme with exchange listed units. The Association of Mutual Funds in India (AMFI) places ETFs in its "Passive" category along with index funds, with separate rows for equity ETF, debt ETF and others.
Buying one and what keeps price near NAV
Consider an ETF with a net asset value (NAV), the value of its holdings per unit, of Rs 100, and a market price on the exchange near Rs 100. An investor buying 50 units through a A demat account is an electronic account that holds an investor's shares, bonds, ETFs and mutual fund units in digital form instead of paper certificates. Read the full meaning of Demat Account will pay about Rs 5,000.
The market price can move slightly away from NAV during the day. Fund house appoints market makers or authorised participants, who keep buy and sell quotes available, and SEBI's passive fund circular sets out a market making framework.
Tracking error is the annualised standard deviation of the difference between the ETF's daily returns and its index, using one year of rolling data. For equity ETFs it must not exceed 2%, except in unavoidable circumstances beyond the fund house's control, and every ETF discloses it daily on the websites of the fund house and AMFI. Debt ETFs are capped on tracking difference at 1.25%.
Why it matters, and ETF vs index fund
ETFs give investors exchange traded access to an index, or to metals such as gold and silver, with tracking limits that are disclosed. Silver ETFs hold physical silver in bars, and gold ETFs hold physical gold of a set purity.
An index fund is often confused with an ETF, as both follow an index. An index fund is bought from and redeemed with the fund house at NAV, and no demat account is required. An ETF needs a demat account and trades at market price on the exchange.