Explained: What makes exchange traded funds attractive

Exchange traded funds are another avenue for investors to take exposure to listed securities.

More popular as portfolios of equity stocks, ETFs are now beginning to take form with debt securities too. They are created in a way that does not require active fund management.

In other words, there is no fund manager to pick and select securities which will be a part of this ETF portfolio. Instead, the portfolio is formed by linking the securities to an existing market index.

The portfolio of the ETF will mirror that of the underlying index for the securities it holds and their weightage. These are considered a low-cost investment option as there is no fee for fund management. There are however some operating costs and costs attached to managing regular inflows and outflows.

Costs in an ETF result in some difference in the ETF return compared to the return of the underlying index—this is referred to as tracking error and serves as one of the parameters that investors need to consider before choosing an ETF.

Unlike other mutual fund schemes, ETFs need a demat account as they are listed and are traded on exchanges. You can invest in an ETF directly with an asset manager.

However, the amount required for that is likely to be proportionately much more that the minimum amount you can buy through the exchange. For long term investors, the low cost in ETFs and the absence of fund manager risk is what makes them attractive.