What are Index funds, Exchange traded funds and Fund of funds

Posted on 22-03-2016        By ADMIN

What are Index funds, Exchangetraded funds and Fund of funds ? 

cs executive capital market and security law notes.

cs professional elective subject security market notes

An Index fund selects a market index and makesinvestments in the basket of stocks drawn from the constituents of that index.
The fund may invest in any or all of the stocksconstituting that index but not necessarily in the same proportion.

Exchange traded mutual funds, popularly known as ETFsalso make investments based on a marketindex or commodity but in fixed number of units, say 1000 units.
This is called a creation basket. Additionally,ETFs are listed on a stock exchange for trading of units.
The role of stock exchanges for ETFs is thatlisting provides liquidity to units in less than creation size. Thus lots ofless than 1000 ETF units can be traded by retail investors at the stockexchanges. In an ETF that are based on a market index, Creation baskets willhave stocks of that index in same proportion as the index.
Hence benchmark will be that particular index. Goldbased ETFs were introduced in 2007. Units of Gold ETFs are backed by physicalgold, not by any index. Hence the benchmark in Gold ETF is not an index, it isthe physical price of gold.

A fund of funds invests in other existing mutualfund schemes. It does not invest directly in securities. The NAV of a fund offunds depends on NAVs of the schemes in which it invests.

A common feature in fund management of Index funds,Exchange traded funds and Fund of funds is that these are largely passiveinvestment strategies.
Instead of churning portfolio in search for winningstocks, fund manager is only expected to perform along with the givenindex/benchmark by staying invested.
Hence total recurring expenses are expected to below compared to active fund management. Presently, maximum annual expenses forindex funds and ETFs are 1.50%. For fund of funds, annual expenses are 0.75%plus the annual charges of underlying schemes that can be transferred toinvestor, maximum limit being 2.50%.

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