Equity ETF

What is an Equity ETF?

An equity exchange-traded fund (ETF) pools money from different investors to buy a portfolio of different stocks. An equity ETF’s primary objective is to replicate the performance of a specific stock market index.

For example, a Nifty 50 ETF tracks the performance of the Nifty 50 broad-market index and provides investors with exposure to the companies that feature in the Nifty 50. Similarly, a Nifty Healthcare ETF aims to replicate the performance of the Nifty Healthcare sectoral index.

One of the key features of an equity ETF is diversification. By providing investors with exposure to a basket of different stocks, these funds effectively reduce risk and enhance wealth-creation opportunities.

How Do Equity ETFs Work?

Equity exchange-traded funds are investment vehicles designed to replicate the performance of an equity market index. These funds are constructed in such a way that they consist of the same stocks in the same proportion and weightage as the underlying index they aim to replicate.

However, unlike regular mutual funds, equity ETFs are listed on the exchanges and traded regularly like stocks. You can freely purchase and sell the units of an exchange-traded fund during market hours using the trading account of a stock broker. Due to this constant trading, the value of an ETF unit fluctuates throughout the day.

Since the primary purpose of equity exchange-traded funds is to merely replicate a market index, fund managers use a passive approach to manage the fund. This essentially means that changes are not made to the ETF’s portfolio unless there is a change in the composition of the underlying index.

As the fund manager is not actively involved in managing an equity ETF, the expense ratio of this category of mutual funds is often very low. The cost-efficiency combined with increased transparency and diversification benefits make these ETFs a highly attractive investment option, especially if you have a high tolerance for risk and a long-term investment horizon.

Types of Equity ETFs

Equity exchange-traded funds can be broadly categorised into five major types depending on their purpose and the market index they track. Here is a quick overview of each of these three categories. 

1. Broad-Market Equity ETF: Broad-market equity ETFs track the performance of broad-market equity indices like the Sensex, Nifty 50 and Nifty 100, among others. 
2. Sectoral Equity ETF: Sectoral equity ETFs aim to replicate the performance of a sectoral market index, such as Nifty Healthcare, Nifty IT, Nifty Infrastructure and Nifty Bank, among others.
3. Thematic Equity ETF: Thematic equity ETFs are designed to track the performance of a thematic market index like Nifty India Consumption, Nifty CPSE, Nifty PSU Bank, Nifty 50 Shariah and S&P BSE Bharat 22, among others.
4. Strategic Equity ETF: Strategic equity ETFs track the performance of an investment strategy-based market index, such as Nifty Dividend Opportunities 50 and Nifty200 Quality 30.
5. Market Capitalisation-Based Equity ETFs: Market capitalisation-based equity ETFs aim to replicate the performance of large-cap, mid-cap, and small-cap market indices like the Nifty Midcap 100.

Benefits of Investing in Equity ETFs

Investing in equity exchange-traded funds offers a plethora of benefits that make them an attractive investment option for both new and experienced investors. Here are some of the key advantages of these ETFs.

1. Diversification: Some of the best equity ETFs provide exposure to a wide range of stocks across sectors and market capitalisations. By investing in such funds, you can effectively diversify and spread investment risk to reduce the impact of poor market performance on your portfolio. 
2. Cost-Effectiveness: Equity exchange-traded funds are a cost-effective way to invest in the stock market, thanks to lower expense ratios. As an investor, you get professionally constructed portfolios while saving on expenses.
3. Liquidity: Since equity ETFs are listed and traded on stock exchanges, they often have high liquidity. This makes it easier to purchase and sell units of the funds on a real-time basis without compromising on price or timing. 
4. Transparency: Equity exchange-traded funds are highly transparent. You can view the fund’s holdings and track its performance in real time, making it easier to make informed investment decisions.
5. Flexibility: With equity ETFs, you get the flexibility to choose the mode of investment. For instance, you can choose to invest a lump sum amount or invest a fixed sum of money regularly over a long period.

Who Should Invest in Equity ETFs?

Equity exchange-traded funds are suitable for a wide range of investors. Let us look at the kind of investors who can benefit from these investment options.

1. New Investors: Equity ETFs could be a good starting point for investors who are new to the stock market. These funds provide exposure to an extensive range of high-quality stocks without the need for in-depth stock-picking knowledge.
2. Passive Investors: Investors who prefer a hands-off approach to investing could also consider investing in some of the best equity ETFs. These funds do not require any kind of active monitoring or the use of complex trading strategies.
3. Cost-conscious Investors: With lower expense ratios compared to actively managed mutual funds, equity exchange-traded funds are the ideal choice for investors looking to minimise costs and maximise returns. With these funds, investors can build efficient and diversified portfolios without compromising on investment quality.
4. Diversification-Seeking Investors: Investors seeking to reduce portfolio risk through diversification can also consider investing in some of the best equity ETFs. By providing exposure to multiple stocks across sectors, market capitalisations and even geographies, these funds can effectively spread investment risk. 
5. Risk-aggressive Investors: Equity ETFs are an ideal investment choice for investors with a high tolerance for market risk and volatility. By investing in funds that focus on high-growth sectors or thematic opportunities, risk-aggressive investors can effectively capitalise on emerging market trends.

How to Choose the Right Equity ETF?

Choosing the best equity ETF for your portfolio may be challenging if you are a beginner. However, with the right strategies, you can easily identify the right ETFs in the equity market. Here is how you can do this.

1. Set Clear Goals: Start by setting clear investment goals. Do you want to focus on growth, income, risk management or wealth creation? These factors will determine which equity ETF may be suitable for your investment objectives.
2. Analyse ETF Holdings: Compare the fund compositions of different equity exchange-traded funds. Some funds may focus on specific sectors, while others may focus on stocks of specific market caps. Choose ETFs whose holdings align with your goals.
3. Check the Costs Involved: Check the expense ratios of the funds you want to invest in. Higher fees can reduce your net returns over time. Low costs can be appealing, but remember to compare them against the fund’s performance to find the cost-benefit ratio.
4. Evaluate the Risk: Monitor the volatility and market exposure for different ETFs to gauge the risk involved. Growth-focused funds may be suitable for aggressive investors but they carry higher risks. Review different funds to find those with risks you can tolerate.
5. Review the Fund’s Management: Research the fund manager’s background and track record to understand how your choice of ETFs may be managed. Most equity ETFs may follow indices, but good management can reduce tracking errors.

How to Invest in Equity ETFs with Angel One?

Step 1: Log in to Angel One trading account using your mobile number/client ID and password.

Step 2: Select ‘ETF’ on the homepage and choose an Equity ETF from the list of ETFs in India.

Step 3: Tap ‘Buy’ and choose between the one-time investment and SIP option.

Step 4: Enter your desired quantity and price of the ETF, then click ‘Buy’ to place an order.

Equity ETFs vs Stock Investing

Although equity exchange-traded funds and stocks are both listed and traded on stock exchanges, there are key differences that set them apart. The table below outlines some of the key distinctions between these two investment options.

Risk Factors in Equity ETFs

Equity exchange-traded funds, being market-linked investments, are not entirely risk-free. They expose investors to various risks, as outlined below.

1. Volatility Risk: Large market swings may cause rapid changes in an ETF’s value. Equity ETFs are particularly prone to quick price rises or drops based on economic developments, company-related news or other triggers that affect investor sentiment.
2. Market Risk: Equity exchange-traded funds track equity indices, which, in turn, align with the prices of the underlying stocks. These prices can fall if market conditions worsen. Factors like unfavourable market news can affect these funds adversely.
3. Regulatory Risk: Changes in government policies or rules like tax laws and industry regulations can all affect stock ETFs. They can impact the cost structure, fund performance and tax implications.
4. Liquidity Risk: Since equity ETFs are traded on exchanges like stocks, they are generally more liquid than mutual funds. However, just like stocks, some ETFs may have limited liquidity and trading volumes. Investors may find it harder to buy or sell these ETFs.
5. Concentration Risk: This is the risk of overexposure to specific stocks or sectors. Equity exchange-traded funds track existing indices. So, if the index’s portfolio is concentrated in some sectors or groups of stocks, the risk is also reflected in the ETF.

Performance Metrics for Equity ETFs

The following metrics can help investors assess the performance of exchange-traded funds in the equity market.

1. Assets Under Management (AUM): Before investing in an equity ETF, check the assets under management. It helps you understand the total amount of money that investors have committed to that ETF. Typically, a high AUM indicates investor confidence. However, the AUM does not guarantee good performance.
2. Expense Ratio: An exchange-traded fund’s expense ratio tells you the annual fee that investors pay to the ETF provider. The lower this ratio is, the better because it may lead to higher net returns. That said, ensure that you weigh the costs against other metrics like fund composition and ETF risks.
3. Fund Beta: The fund beta measures how sensitive a stock ETF is to swings in the broader market. If the beta is 1, it means that the ETF moves as much as the market, in the same direction. Higher beta values mean increased volatility, while lower beta values indicate reduced volatility.
4. Sharpe Ratio: This ratio assesses the risk-adjusted returns from an equity exchange-traded fund. It evaluates the returns delivered for the risk taken. Higher Sharpe ratios point to better risk-adjusted returns. Nevertheless, consider this ratio alongside other parameters because historical returns do not ensure future performance.

Tax Considerations for Equity ETFs

Any dividend income earned from equity ETFs is considered a part of the investor’s total annual income. It is, therefore, taxed as per the income tax slab applicable to the assessee.

Capital gains from equity exchange-traded funds are taxed based on the holding period and the date of sale, as outlined below.

• Short-Term Capital Gains (STCG): Profits from equity ETFs for which the holding period is 12 months or less are called short-term capital gains. Till July 23, 2024, STCG from these exchange-traded funds was taxed at 15%. However, from July 23, 2024, the tax rate was increased to 20%.

• Long-Term Capital Gains (LTCG): Any profits earned from equity exchange-traded funds held for more than 12 months will be long-term capital gains. Till July 23, 2024, LTCG exceeding ₹1 lakh from these funds was taxed at 10%. However, from July 23, 2024, the tax rate for LTCG over ₹1.25 lakh from equity ETFs was raised to 12.5%.

Top 5 Equity ETFs Based on 5-Yr CAGR

Note: The best equity ETFs list provided here is as of January 21, 2025. The ETFs have been selected using a tracking error range of 0 to 0.05 and an expense ratio range of 0 to 0.14, and are sorted based on the 5-year CAGR.

1. Bharat 22 ETF: This equity ETF is benchmarked against the BSE Bharat 22 index. It gives investors exposure to select 22 companies disinvested by the Indian government. With a low tracking error, the fund is expected to track the benchmark index more closely. 

   Key Metrics: 

   • 1-year Return: 15.34%
   • Tracking error: 0.03
2. IDFC Nifty 50 ETF: This equity exchange-traded fund tracks the NSE’s benchmark index, Nifty 50. Investing in this fund gives you exposure to the top 50 companies listed on this stock exchange. 

   Key Metrics: 

   • 1-year Return: 11.43%
   • Tracking error: 0.05
3. Invesco India Nifty 50 ETF: Also benchmarked against the Nifty 50 index, this stock ETF is said to accrue returns that closely mirror the index’s performance. The fund focuses on the largest companies on the NSE, making it preferable for conservative equity investors. 

   Key Metrics: 

   • 1-year Return: 11.79%
   • Tracking error: 0.03
4. Nippon India ETF Nifty 50 BeES: The Nippon India ETF Nifty 50 BeES is a benchmark exchange-traded scheme that also tracks the NSE’s broad market index, Nifty 50. This equity ETF is also closely aligned with the benchmark index.

   Key Metrics: 

   • 1-year Return: 11.25%
   • Tracking error: 0.03
5. ICICI Prudential Nifty 50 ETF: This is another equity exchange-traded fund that is composed to mirror the Nifty 50. What sets it apart as one of the best ETFs in the equity segment is its high historical returns. 

   Key Metrics: 

   • 1-year Return: 11.24%
   • Tracking error: 0.03