Exchange Traded Funds (ETFs) are passive investment instruments. They offer direct investment exposure to underlying indices or commodities like silver, gold etc. As per the guidelines of the Securities and Exchange Board of India (SEBI), an ETF must deploy at least 95% of its assets in securities of the underlying index.
Before discussing the answer to: what are the different types of ETFs one can invest in, it's helpful to note that ETFs provide several benefits to investors. These include diversification of investment portfolio, the convenience of investing, simplicity of understanding, and potential elimination of unsystematic risks. ETFs emerge as a cost- effective investment option for investors seeking a simplified approach to investing investment exposure to broader markets.
If you are wondering how many types of ETFs are there, here is an indicative list of types of ETFs to invest in:
Equity ETFs
As the name suggests, equity ETFs track an underlying broad market equity index like S&P BSE Sensex, NSE Nifty50, NSE Nifty Next50 etc. or sectoral/thematic indices like Nifty Bank, Nifty Auto, CPSE etc. or strategy of factor-based equity indices like Nifty 200 Momentum 20, Nifty Midcap Quality of Nifty Low Volatility etc. According to the chosen scheme, investors directly have exposure to the particular equity market index.
Such equity ETFs may also be categorised into domestic and international equity ETFs. Domestic equity ETFs track equity indices in domestic markets, while international equity ETFs invest in foreign equity shares forming part of international equity indices. One can choose between different available ETFs per their risk appetite, investment horizon and financial goals.
Debt ETFs
Such ETFs invest in debt indices like gilt indices, money market indices, etc. Such ETFs aim to fulfil the debt allocation for the investment portfolio. With such debt ETFs, one can also target creating a maturity basket of debt ETFs maturing in different years. When investors hold on to such target maturity ETFs till maturity, the interest rate risk on such ETFs is mitigated, and investors can target the yields prevailing at the investment time.
Commodity ETFs
Such ETFs invest in different physical commodities like gold, silver, etc. As such, the investors can have direct investment exposure to investing in commodities without worrying about the physical storage and security of such commodity stock.
Since the investment portfolio of commodity ETFs comprises physical stock, the price changes for the commodities are reflected in the valuation changes of the ETF portfolio. Investors generally use commodity ETFs to diversify their investment portfolios into different asset classes.
Investing in ETFs
One can trade in ETF units over stock exchanges like other equity shares. One may consider investing in an ETF, which has a larger volume on stock exchanges. Higher liquidity for ETF units enables the investors to have a higher probability of trade execution at the stock exchanges with lower impact costs. Further, mutual fund houses may also act as market makers for ETF units to generate liquidity on stock exchanges for investors.
Taxation of gains from ETF units
Under the Income Tax Rules, the returns generated by the investors on the sale of ETF units are taxed as Capital Gains. Such gains may be classified as short-term and long- term depending on the ETF investment pattern and holding period of such units.
Equity ETFs (except international equity ETFs) are taxed like equity-oriented funds, while international equity ETFs, debt ETFs and commodity ETFs are taxed as non-equity- oriented funds. The summary of the tax rates applicable is given below:
| Classification of ETF | Holding Period | Capital Gain | Tax Rate |
|---|---|---|---|
| Equity-oriented ETF | Less than 12 months | Short-Term Capital Gain (STCG) | 15% |
| 12 months or more | Long-Term Capital Gain (LTCG) | 10% after an exemption of Rs. 1 lakh for LTCG from equity shares and equity funds in aggregate in a financial year | |
| Other than equity- oriented ETF | Less than 36 months | STCG | Regular tax rates |
| 36 months or more | LTCG | 20% with indexation |
Disclaimer-
Mutual Fund investments are subject to market risks, read all scheme related documents carefully.
The tax provisions mentioned in the article are for illustrative purposes only and are updated as per the Union Budget 2022 presented in the Parliament in February 2022. The tax rates for capital gains are exclusive of the applicable cess and surcharge, and such tax rates will be as per the tax laws applicable on the date of redemption/ sale and not on the date of investment. Please contact your tax advisor for professional tax advice.
