Exchange-Traded Funds, or ETFs, are a type of Mutual Funds which have recently stirred India’s equity markets. ETFs track their benchmark index by investing in a portfolio almost identical to the composition of the benchmark index. Hence, ETFs pool funds from investors who want to invest in the overall index for diversification benefits.
Unlike Mutual Funds, ETFs are passively managed and incur minimal management expense fees, called the expense ratio. Investing in ETFs involves other small charges like brokerage charges and Securities Transaction Taxes. Such costs should be taken into account when calculating your returns.
Expense ratios are the major costs involved in ETFs or Mutual Funds. The net expense ratio includes waivers, reimbursements, and trading costs, whereas the Gross expense ratio is equal to the percentage of total mutual fund assets used to run the fund.
The expense ratio is a measure of the annual fund operating expenses of an investment fund. It is expressed as a percentage of the fund’s assets under management (AUM). The fund’s operating expenses include spends on administration, management, and advertising
The expense ratios for ETFs range from 0.1% to 0.7% per annum which includes all the fees the fund house is charging. Within Mutual Funds, a direct mutual fund incurs an expense ratio of about 1% per annum. The regular mutual funds, which are purchased through brokers and agents, attract an expense ratio of around 1.5-2% per annum.
Entry load is the commission paid by the investor to the fund manager for participating in that fund. SEBI doesn’t allow fund houses to charge entry load from investors.
Exit load is charged by funds when you withdraw your money from the fund. It is the fee charged by fund houses to discourage investors from early withdrawals.
Since ETFs trade like shares on a stock exchange, there is no entry or exit load involved in dealing with ETFs. Investors can buy and sell the shares of the ETF just like other stocks.
Some Mutual Funds, on the other hand, involve an exit load. Because of no exit or entry load, ETFs enjoy good liquidity on the stock exchanges. SEBI has permitted an exit load of up to 7%, for Mutual Funds, but most mutual funds charge from 1% of the AUM if you withdraw within 1 year of investing. There is no exit load if you with sell off the units 1 year after you purchased them.
Brokerage, STT and Other Charges
Your broker also charges certain fees for its services, called brokerage charges. The average brokerage charge on purchasing ETFs is 0.01% of the turnover value.
There are certain charges which the SEBI levies on purchase of stocks from an exchange. Since ETFs also trade like stocks and are listed on the exchange, ETFs attract such charges from SEBI. Apart from that, STT stands for Securities Transactions Tax and stands at 0.01% of your turnover value.
Demat Transaction charges is fee charged by your Depository institution to keep your shares in a demat form. DTC charges range from Rs. 15-40 depending on your broker and his Depository Participant.
18% GST is also charged by the Government of India on brokerage + transaction charges. These are levied on both, ETFs and Mutual Funds but forms a very small part of the overall fee.
Below is a table which shows what happens to your investment after a year of investing them in ETFs and Mutual Funds for up to 1 year. We assume that both the funds gave a 0% return, for simplicity of calculation.
Disclaimer: Investments in equity investments is subject to market risk. Please contact your financial advisor before making an investment.