ETF or Index Fund?

Should one invest in an Exchange Traded Fund (ETF) or an index fund?  

The decision depends on the need of the investor. 

A corporate treasury who has done derivative trades would prefer an ETF because they get real-time prices to exit and enter. 

Retail investors who wish to invest for the long term and are not concerned with intraday prices, would prefer index funds. 

Further, if one wants to opt for a systematic investment plan (SIP), then an index fund is the right vehicle, not an ETF. 

For first time investors, the simplicity and low-cost structure is a good starting point.  Even if they do not have a demat account or a stock broking account, they can access the equity market via an index fund. 

Keeping aside retail investors, a few entities such as certain trusts, cooperative societies and some corporate entities, whose existing articles do not permit the operating of a trading and demat account, would opt for index funds. 

In the current volatile markets, many institutional treasuries and family offices are taking tactical calls on the equity market by investing via low cost, exit load free index funds. A few suggestions to keep in mind when investing: 

• When considering allocation to passive funds, it need not be to the exclusion of active funds. An investor can invest in both, active and passive funds. Don’t view passive funds as a competing strategy but rather, a complementary strategy. 
• Investors should avoid passive funds based on mid- and small-cap themes. It is in these segments, which is often under-researched, that the potential to outperform the benchmark or generate alpha exists. Mid and small cap allocation can be in active funds. 
• In ETFs, there is often a difference between the fair value of an ETF and the prices quoted on the exchanges. This is all the more evident if there is inadequate liquidity on the exchange. Hence investors should review the past trading volumes of an ETF before investing in it. 
• Investors can also easily check the real-time INAV (indicative NAV) before executing a trade on the exchange – the INAV which indicates a real-time fair value per unit is mandatorily published on the website of the AMC. If a retail investor wants to exit and if he/she doesn’t get the fair value, then the overall investment experience is bad. Hence investors should look for ETFs where the divergence between INAV and the price traded is minimum. 
• In an ETF, investors need to look beyond the total expense ratio, or TER. They must look at the total cost of ownership, or TCO. This includes all expenses (brokerage, taxes paid on buy and sell transactions on the stock exchange, annual demat account charges, bid/offer spread, etc.).