Exchange Traded Funds

Executive Summary ETF’s are the hybrid type of mutual fund which can be traded as share or stock on the Exchange. Exchange traded funds are one of the most preferred investment vehicles in the matured markets like USA, UK, Japan, Germany etc. Exchange traded funds were launched in the year January 2002 in India. There are 8 types of ETF which are launched in India. The majority of investment in lefts happens in the GETF. The reasons why ETF’s are not popular in the India are lack of product variability in the ETF’s. The market of ETF’s in India has lack of liquidity and product knowledge about the product in the general public and with big shots such as Foreign Institutional Investors, Domestic Financial Institutions and High Net worth Individuals. The project contains the evolution and types of ETF’s in the world and in India. The project also contains the case study on the GETFS. ETF’s in the mature markets have involved into Active Exchange Traded Funds and Exchange Traded Notes. There is big difference between volume where the daily volume of a particular Scrip, i.e. NASDAQ-100 (Ticker: QQQQ) is of 89 million units in one day itself on New York Stock Exchange whereas in India there are not even 500 units traded per day (other than Gold ETF’s) and hardly 15000 units in terms of Gold ETF’s. The ETF helps in providing a positive return while the market is falling; such an ETF is called Bear Market ETF. As the regulations in India are such that, the introduction of a very complex product in Derivatives or ETF or MF is next to zero. The project also includes a summary of SEBI guidelines for Exchange Traded Funds.

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Exchange Traded Funds – Introduction Definition- An exchange-traded fund (or ETF) is an investment vehicle traded on stock exchanges, much like stocks or bonds. An ETF holds assets such as stocks, bonds, or futures. Institutional investors can redeem large blocks of shares of the ETF (known as "creation units") for a "basket" of the underlying assets or, alternatively, exchange the underlying assets for creation units. This creation and redemption of shares enables institutions to engage in arbitrage and causes the value of the ETF to approximate the net asset value of the underlying assets. Most ETFs track an Index, such as the Dow Jones Industrial Average or the S&P 500. An ETF combines the valuation feature of a mutual fund or unit investment trust, which can be purchased or redeemed at the end of each trading day for its net asset value, with the tradability feature of a closed-end fund, which trades throughout the trading day at prices that may be substantially more or less than its net asset value. Closed-end funds are not considered to be exchange-traded funds, even though they are funds and are traded on an exchange. ETFs have been available in the US since 1993 and in Europe since 1999. ETFs traditionally have been Index funds, but in 2008 the U.S. Securities and Exchange Commission began to authorize the creation of actively-managed ETFs. U. S. Securities and Exchange Commission Definition- Exchange-traded funds, or ETFs, are investment companies that are legally classified as open-end companies or Unit Investment Trusts (UITs), but that differ from traditional open-end companies and UITs in the following respects: ETF’s do not sell individual shares directly to investors and only issue their shares in large blocks (blocks of 50,000 shares, for example) that are known as "Creation Units." Investors generally do not purchase Creation Units with cash. Instead, they buy Creation Units with a basket of securities that generally mirrors the ETF’s portfolio. Those who purchase Creation Units are frequently institutions.

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After purchasing a Creation Unit, an investor often splits it up and sells the individual shares on a secondary market. This permits other investors to purchase individual shares (instead of Creation Units). Investors who want to sell their ETF shares have two options: (1) they can sell individual shares to other investors on the secondary market, or (2) They can sell the Creation Units back to the ETF. In addition, ETFs generally

redeem Creation Units by giving investors the securities that comprise the portfolio instead of cash. So, for example, an ETF invested in the stocks contained in the Dow Jones Industrial Average (DJIA) would give a redeeming shareholder the actual securities that constitute the DJIA instead of cash. Because of the limited redeem ability of ETF shares, ETFs are not considered to be—and may not call themselves—mutual funds.

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ETF: The History Exchange Traded Funds came into existence in 1993 when, State Street Global Advisors, together with the American Stock Exchange, developed and launched the ETF market. The name of the product was SPDRS. SPDR, which is benchmarked against the S&P 500 Index, continues to be the most successful product with over $22 billion in Assets under Management (AUM). It currently enjoys tremendous liquidity, averaging close to $1 billion in shares changing hands every day on the American Stock Exchange. In fact, it consistently ranks as one of the most active securities on the American Exchange (AMEX). In addition to launching the SPDR, State Street Global Advisors and the AMEX also launched the Dow Diamonds in 1998, benchmarked against the Dow Jones Industrial Average. That year they also introduced the first sector ETFs, the Select Sector SPDRs, benchmarked against the nine sectors making up the S&P 500 Index. In 1999, they introduced the first ETF in Asia and currently they are doing the same in other major markets around the globe. Now subsequent to the roaring success of the ETF market, more and more complex instruments revolving around the ETFs are coming into being. Such an innovation are options and futures on ETFs. On November 18, 2002, EUREX (European Exchange) launched Europe's first futures and options on the most liquid ETFs.

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How ETFs work? ETFs are securities certificates that state legal right of ownership over part of a basket of individual stock certificates. Several different kinds of financial firms are needed for ETFs to come into being, trade at prices that closely match their underlying assets, and unwind when investors no longer want them. Laying all the groundwork is the fund manager. This is the main backer behind any ETF, and they must submit a detailed plan for how the ETF will operate to be given permission by the SEC to proceed. In theory all that a fund manager needs to do is establish clear procedures and describe precisely the composition of the ETF (which changes infrequently) to the other firms involved in ETF creation and redemption. In practice, however, only the very biggest institutional money management firms with experience in indexing tend to play this role, such as The Vanguard Group and Barclays Global Investors. They direct pension funds with enormous baskets of stocks in markets all over the world to loan stocks necessary for the creation process. They also create demand by lining up customers, either institutional or retail, to buy a newly introduced ETF. The creation of an ETF officially begins with an authorized participant, also referred to as a market maker or specialist. Highly scrutinized for their integrity and operational competence, these middlemen assemble the appropriate basket of stocks and send them to a specially designated custodial bank for safekeeping. These baskets are normally quite large, sufficient to purchase 10,000 to 50,000 shares of the ETF in question. The custodial bank doublechecks that the basket represents the requested ETF and forwards the ETF shares on to the authorized participant. This is a so-called in-kind trade of essentially equivalent items that does not trigger capital gains for investors. The custodial bank holds the basket of stocks in the fund's account for the fund manager to monitor. There isn't too much activity in these accounts, but some cash comes into them for dividends and there are a variety of oversight tasks to perform. Some managers have leeway to use derivatives to track an index. 5

This flow of individual stocks and ETF certificates goes through the Depository Trust Clearing Corp., the same US government agency that records individual stock sales and keeps the official record of these transactions. It records ETF transfer of title just like any stock. It provides an extra layer of assurance against fraud. Once the authorized participant obtains the ETF from the custodial bank, it is free to sell it into the open market. From then on ETF shares are sold and resold freely among investors on the open market. Redemption is simply the reverse. An authorized participant buys a large block of ETFs on the open market and sends it to the custodial bank and in return receives back an equivalent basket of individual stocks which are then sold on the open market or typically returned to their loanees. What motivates each player? The fund manager takes a small portion of the fund's annual assets as their fee, clearly stated in the prospectus available to all investors. The investors who loan stocks to make up a basket make a small interest fee for the favor. The custodial bank makes a small portion of assets likewise, usually paid for by the fund manager out of management fees. The authorized participant is primarily driven by profits from the difference in price between the basket of stocks and the ETF and on part of the bid-ask spread of the ETF itself. Whenever there is an opportunity to earn a little by buying one and selling the other, the authorized participant will jump in. The process might seem cumbersome but it does allow for transparency and liquidity at modest cost. Everyone can see what goes into an ETF, investor fees are clearly laid out, investors can be confident that they can exit at any time, and even the authorized participant's fees are guaranteed to be modest. If one allows ETF prices to deviate from the underlying net asset value of the component stocks, another can step in and take profit on the difference, so their competition tends to keep ETF prices very close to it underlying Net Asset Value (value of component stocks).

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How ETFs are Traded The trading of the ETF is based on a well-known mechanism called arbitrage. But first, let us see how one can buy an ETF. There are two ways in which one can buy an ETF. One is through the market and the other is through the fund house that has issued the ETF. Now for the pricing mechanism: if the demand of the ETFs in the markets soars, the ETF would start trading at a premium from its intrinsic value, which should be equal in proportion to the index that it is charting. This premium would make the buyers go to the fund house where they would have to redeem their shares in the proportion held under each unit of the ETF. Such units that are bought directly from the fund house are called "creation units". But usually the lot size in which one can buy creation units is so high that only an authorized participant (market maker) or institutional investors may have the wherewithal to buy these. In such case the retail investor would have to go to the market itself to buy the units of the ETF, the decision in turn depending on the expectations of the future price movements of the ETF. In case of redemption in the market, the seller would get paid in cash and in case the fund units are taken to the issuer, the seller would get paid in kind that is the underlying shares that make up the index. ETF trading also opens up the flood gates for some more complex trading arrangements like arbitrage between the cash and futures market or simply put - short selling. But there is a hitch as far as the Indian capital markets is concerned: "shorting" is not allowed. As a proxy, one can borrow the units but that mechanism is not very efficient, as the cost of borrowing happens to range between 12 to 18 per cent depending on one's creditworthiness. Given below is a chart that explains the trading mechanism

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Advantages of ETFs While many investors have similar outlooks, no two are exactly alike. Due to the unique structure of ETFs, all types of investors, whether retail or institutional, longterm or short-term, can use it to their advantage without being at a disadvantage to others. They allow long-term investors to diversify their portfolio at one shot at low cost and insulate them from short-term trading activity due to the unique “in-kind” creation / redemption process. They provide liquidity for investors with a shorter-term horizon as they can trade intra-day and can have quotes near NAV during the course of trading day. As initial investment is low, retail investors find it simple and convenient to buy / sell. They facilitate FII’s, Institutions and Mutual Funds to have easy asset allocation, hedging, and equitising cash at a low cost. They enable arbitrageurs to carry out arbitrage between the Cash and the Futures markets at low impact cost. ETFs provide exposure to an index or a basket of securities that trade on the exchange like a single stock. They offer a number of advantages over traditional open-ended index funds as follows: 1.

While redemptions of Index fund units takes place at a fixed NAV price (usually end of day), ETFs offer the convenience of intra-day purchase and sale on the Exchange, to take advantage of the prevailing price, which is close to the actual NAV of the scheme at any point in time. They provide investors a fund that closely tracks the performance of an index throughout the day with the ability to buy/sell at any time, whereby trading opportunities that arise during a day may be better utilized.

2.

They are low cost. Unlike listed closed-ended funds, which trade at substantial premia or more frequently at discounts to NAV, ETFs are structured in a manner which allows Authorized Participants and Large Institutions to create new units and redeem outstanding units directly with the fund, thereby ensuring that ETFs trade close to their actual NAVs.

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3.

ETFs are like any other index fund, wherein, subscription / redemption of units work on the concept of exchange with underlying securities instead of cash (for large deals).

4.

Since an ETF is listed on an Exchange, costs of distribution are much lower and the reach is wider. These savings in cost are passed on to the investors in the form of lower costs. Further, the structure helps reduce collection, disbursement and other processing charges.

5.

ETFs protect long-term investors from inflows and outflows of short-term investors. This is because the fund does not incur extra transaction cost for buying/selling the index shares due to frequent subscriptions and redemptions.

6.

Tracking error, which is divergence between the NAV of the ETF and the underlying Index, is generally observed to be low as compared to a normal index fund due to lower expenses and the unique in-kind creation / redemption process.

7.

ETFs are highly flexible and can be used as a tool for gaining instant exposure to the equity markets, equitising cash or for arbitraging between the cash and futures market.

8.

Tradable and Diversifiable: The ultimate selling proposition of an ETF lies in its twin feature of being tradable and diversifiable. One can trade a stock but then it is not diversifiable. Or, one can buy a mutual fund and thereby diversify but then the mutual fund would not be tradable. Alternatively, one can diversify one's risks by holding a portfolio of stocks and trade them but that would be too much of a botheration for the lay investor. These conflicts are reconciled by an ETF that is at once tradable and is a diversified portfolio too. It is these two features, working in tandem, like the twin blades of a scissor that make it a financial product of choice.

9.

Transparency: Just like the index fund, the portfolio of an index fund has no mystery to it. Everybody in the participating market is aware of the stocks that it is tracking and therefore need not worry about a change in the stocks being traded in. 10

10.

Makes multiple trading strategies possible: As has been said earlier, ETFs have the utility of doubling up as arbitraging instruments between the futures and cash markets. It also helps in equitizing cash, i.e., changing cash into equities, at a low cost.

11.

A Bear market friend: In a volatile stock market, an ETF might become an instrument of choice as it is not expected to be as volatile and yet may be traded. This is borne out by the fact that the assets of US ETFs have grown from $ 96 billion in January 2003 to $118 billion in May 2003.

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The Risks 1.

The performance of ETFs that track a concentrated/sector index could be more volatile than the performance of diversified funds.

2.

Like other index-tracking funds, ETF is not actively managed, meaning that the fund manager does not have the discretion to select stocks or secure defensive positions in declining markets. Hence, any fall in the underlying index will result in a corresponding fall in the value of the ETF.

3.

There is no assurance that the performance of the ETF will be identical to the performance of the underlying index due to factors such as tracking errors.

4.

Although listed on a stock exchange, ETFs face the risk of not being actively traded, i.e. liquidity problems.

5.

The market price of the ETF unit could be higher or lower than its NAV per unit due to market demand and supply and liquidity.

6.

Absence of prior active market: In India ETFs being a new instrument, there is no existing market that one could swim into immediately after buying the product. So for the liquidity to be reasonable, a large number of investors would have to buy into the idea to make adequate liquidity possible.

7.

Large Investments: In order to deal directly with the fund houses large capital investments are required. For example in the case of Nifty BeES, a minimum creation unit size of 20000 units is required that would involve lakhs of rupees in investment. This makes ETFs a market where the institutional buyers and sellers become the big fish.

8.

Broker Charges: Broker charges have to be paid anyway when trading in ETFs. This can be minimized by trading long but the very charm of ETFs is destroyed because it is meant for being traded more often than an index fund.

9.

Premiums and discounts: An ETF might trade at a discount to the underlying shares. This means that although the shares might be doing very well on the bourses, yet the ETF might be traded at less than the market value of these stocks.

10.

Does not facilitate "rupee cost averaging": An ETF is not appropriate for those investors who want to operate on the strategy of "rupee cost averaging". 12

This is because investors investing some money into ETFs every month would have to incur brokerage costs that are not to be incurred in case of mutual fund units until and unless the scheme carries an entry load.

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Types of ETFs ETFs can be broadly classified as Indexed ETFs and Actively managed ETFs. Indexed ETFs: Indexed ETFs (sometimes referred to as Classical ETFs) typically offer low management fees, since they have a low operating cost structure. Reasons for the low cost structure are as follows: •

The fund manager does not have to exercise a high level of administration, as investors wanting to buy or sell units can only do so on a particular index (such as the S&P/ASX 200)

•

The turnover of underlying shares in the portfolio is minimal as the fund tracks a share market index. In addition, once the target investment portfolio is established, there is no ongoing need for the ETF manager to undertake research, since the portfolio composition is determined by the index.

Actively Managed ETFs: Actively managed ETFs provide access to a much broader range of investment management styles, strategies, asset classes and operational practices than indexed ETFs. Additionally, actively managed ETFs can usually accept cash applications, which means investors, can buy units directly from the fund manager through lodging an application form contained in the fund prospectus as well as to buy units already issued on that index. Sector ETFs: Almost one third of the available ETFs give you exposure to sectors. These are industry groups such as communications, financial, health care, natural resources, precious metals, real estate, technology, and utilities. These sectors can be volatile and often go from media darlings to fallen stars rather quickly, but they also give investors an easy way to climb aboard a hot trend.

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International ETFs The major country indexes of many third-world countries have brought investors firstclass returns in recent years. ETFs tracking China and Brazil have been among the biggest winners. You can diversify with broad emerging market ETFs which invest around the globe or focus on key regions such as Asia, Europe and Latin America. Commodities ETFs Oil and gold prices have recently smashed their all-time records, and ETFs that track those commodities have become very popular. A shortage of raw materials and the rapid growth of countries like China have also driven up prices of other commodities. ETFs focusing on agricultural commodities are also gaining steam. Bond ETFs Again, there are a lot of choices here, including short-term, intermediate-term, and long-term government bonds. Other options: corporate bonds, municipal bonds, and emerging market bonds. Currency ETFs You can use ETFs to wager on the direction of the yen, euro, dollar, and about a dozen other currencies. Bear Market ETFs These ETFs gain popularity when markets start to go down. They make gains when the index they cover loses value. For example, if the S&P 500 falls in price, ETFs that directly track it like the SPDR S&P 500 will suffer losses, while ETFs like UltraShort S&P500 ProShares that short the index will make gains.

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Comparison of ETFs with other mutual funds In essence, ETF's trade like stocks and therefore offer a degree of flexibility unavailable with traditional mutual funds. Specifically, investors can trade ETFs throughout the trading day as in stocks. In comparison, in a traditional mutual fund, investors can purchase units only at the fund’s NAV, which is published at the end of each trading day. In fact, investors cannot purchase ETFs at the closing NAV. This difference gives rise to an important advantage of ETFs over traditional funds: ETFs are immediately tradable and consequently, the risk of price differential between the time of investment and time of trade is substantially less in the case of ETFs. ETFs are cheaper than traditional mutual funds and index funds in terms of fees. However, while investing in an ETF, an investor pays a commission to the broker. The tracking error of ETFs is generally lower than traditional index funds due to the “inkind” creation / redemption facility and the low expense ratio. This “in-kind” creation / redemption facility ensures that long-term investors do not suffer at the cost of short-term investor activity. ETFs can be bought / sold through trading terminals anywhere across the country. Table No. 1 presents a comparative view ETFs vis-à-vis other funds. ETFs vs. Open Ended Funds vs. Close Ended Funds (Table No. 1) Parameter Open Ended Closed Ended Fund Exchange Traded Fund Fund Size NAV Liquidity Provider Sale Price Availability Portfolio Disclosure Uses Intra-Day Trading

Fund Flexible Daily Fund itself

Fixed Daily Stock Market

Equalising cash

-

Not possible

Expensive

Flexible Real Time Stock Market / Fund itself At NAV plus Significant Premium / Very close to actual load, if any Discount to NAV NAV of Scheme Fund itself Through Exchange Through Exchange where listed where listed / Fund itself. Monthly Monthly Daily/Real-time Equitising Cash, Hedging, Arbitrage Possible at low cost

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Source- www.nse.com ETF

Comparison

-

While

similar

to

an

index

mutual

fund,

ETFs differ from mutual funds in significant ways. Attribute

ETF

Index Mutual Fu

Individual Stock

Diversification

Yes

nd Yes

No

Traded throughout the day

Yes

No

Yes

Can be bought on margin

Yes

No

Yes

Can be sold short

Yes

No

Yes

Tracks an index or sector

Yes

Yes

No

Tax efficient as turnover is Yes

Possibly

No

low Low Expense Ratio

Yes

Sometimes

Not a factor

Trade at any brokerage firm

Yes

No

Yes

In 1992, the American Stock Exchange (Amex) made use of the Securities and Exchange Commission's (SEC) "SuperTrust Order" to request use of the first authorized stand-alone index based exchange-traded fund (ETF). That petition was approved by the SEC and it paved the way for the release of the S&P Depository Receipts Trust Series 1, or "SDPRs". In time, they quickly gained acceptance in the marketplace and became the first commercially successful ETF. The first U.S. listed ETF was the SPDRs (Ticker: SPY) which launched on the Amex in 1993. The fund is benchmarked to the Standard & Poors' 500 Index. Later on, ETFs based upon widely followed benchmarks like the NASDAQ-100 (Ticker: QQQQ), Dow Jones Industrial Average (Ticker: DIA) and others would follow.

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Key Legal Structures Traditional bond and equity ETFs are generally organized as open-end funds or Unit Investment Trusts (UITs). Investment products that track commodities, currencies, or other specialized strategies are typically registered as grantor trusts, exchange-traded notes, or partnerships. Although some of these structures share similar characteristics to traditional ETFs, they are not necessarily registered or taxed the same. As the ETF universe evolves, the variety of product structures will likely follow suit. Here's a brief summarization of related legal structures. Open-end index fund The majority of ETFs follow the open-end structure because it allows the greatest flexibility. Dividends in these types of funds are immediately reinvested and paid to shareholders on a monthly or quarterly basis. This ETF design is also permitted to use derivatives, portfolio optimization, and lend securities. Open-end funds are registered under the Investment Company Act of 1940. ETF families that have this legal structure include iShares, Select Sector SPDRs, PowerShares, Vanguard, and WisdomTree. Unit Investment Trust (UITs) The oldest and best known ETFs - including the BLDRs, Diamonds, SPDRs, and PowerShares QQQ Trust - are organized as UITs. This type of legal structure does not reinvest dividends in the fund, but instead holds dividends until they're paid to shareholders quarterly or annually. These mechanics cause a situation known as "dividend drag." UITs must fully replicate the indexes they track and receiving income from loaned securities is not permitted. Unlike open-end funds, UITs have expiration dates which can range from a period of years to decades. Most expiration are continuously rolled or extended. UITs are registered under the Investment Company Act of 1940. 18

Grantor Trust This type of legal structure distributes dividends directly to shareholders and allows them to retain their voting rights on the underlying securities within the trust. The original securities in a grantor trust remain fixed and aren't rebalanced. Grantor trusts are registered under the Securities Act of 1933. The streetTRACKS Gold Shares, iShares Silver Trust, Merrill Lynch's HOLDRs and CurrencyShares follow this format. Partnerships Some index linked products that resemble ETFs are actually operated as master limited partnerships (MLPs). Unit holders are required to report their share of the MLP's income, gains, losses and deductions on their federal income tax returns even if cash distributions are not made.

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ETF Legal Structures Open

End

Fund Unit Investment Trust Grantor Trust ExchangeTraded Notes Partnership s

Products iShares, Select Sector SPDRs, PowerShar es, Vanguard, and WisdomTre e BLDRs,

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Source: ETFguide.com

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Active Exchange Traded Funds The exchange traded fund (ETF) universe has officially been infiltrated by active managers. Once exclusively hailed as a type of index-based, passive vehicle, ETFs are now exploring the active side of portfolio management. There are many ETFs to choose from, and the choices no longer only appeal to traditional indexers. In this article, we'll take a look at the inception of actively traded ETFs and what this could mean for investors. What Are Active ETFs? Active ETFs combine the benefits of ETF investing with the investment process of active management. Despite the strong track record that indexing strategies have demonstrated, many investors are simply not content to settle for average returns. The ETF structure, by design, provides investors with lower expenses, tax efficiency, fund transparency, liquidity and trading flexibility. Until active ETFs came to market, most ETFs were designed to track a specific index or industry sector. Active ETFs are managed by investment teams relying on traditional portfolio management methods (research, managed risk, active trading) with the specific goal of outperforming a relative benchmark. Of course, whether you choose to believe that is possible on a consistent basis is another matter altogether, and beyond the scope of this article. The Unveiling Active ETFs made their official debut on April 11, 2008, although you could argue that some of the existing passive products bear strong resemblance to active strategies. There is no doubt that providers of these actively managed ETFs are banking on active management as a way to attract new investors and compete more effectively with mutual funds in a very crowded marketplace. This very first generation of active ETFs was pioneered by PowerShares Capital Management. Their lineup of products includes: 22

•

Active AlphaQ (PSE), benchmarked against the Nasdaq-100 index; expense ratio 0.75%

•

Active Alpha Multi-Cap (PSE), benchmarked against the S&P 500 index; expense ratio 0.75%

•

Active Mega-Cap (PSE), benchmarked against the Russell Top 200 index; expense ratio 0.75%

•

Active Low-Duration (PSE), benchmarked against the Lehman Brothers 1-3 year U.S. Treasury index; expense ratio 0.29%

Comparing Active ETF's Actively Managed Funds There are many differences that set active ETFs apart from actively managed funds. Among them are the tax advantages. Mutual funds use a highest in, first out method of tax treatment and portfolio tax management. This method often creates embedded, unrealized gains, which can lead to eventual taxable distributions to shareholders. Active ETFs, on the other hand, endorse a `strategy that may better mitigate or avoid capital gains distributions via in-kind tax management strategies. With this approach, the ETF fund manager can purge the lowest basis stocks via inkind stock transfers through the creation and redemption process. This helps systematically reduce the tax exposure for investors. Additionally, because ETFs report their holdings on a daily basis, active ETFs will provide far greater transparency than funds that do not disclose their holdings as frequently, such as once per quarter. Daily reporting of assets is necessary to facilitate the creation and redemption of fund shares, a process that helps to keep the fund's price in line with its net asset value (NAV). Finally, active ETFs have dramatically lower expenses as compared to the average actively managed mutual fund, but of course, this is largely determined by the asset class being represented in the fund. For example, domestic large cap funds tend to have lower expenses, in general, than foreign

asset

classes

in

less

developed

markets.

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Passively Managed ETF's From an investment strategy standpoint, traditional exchange-traded funds (ETFs) are designed to track indexes. Active ETFs, by contrast, are designed to beat an index. Both passive and active ETFs attempt to minimize shareholders costs, but actively managed ETFs might not be as tax efficient as ETFs that track indexes due to increased turnover. Still, active ETFs, as previously discussed, are likely more tax efficient than their mutual fund counterparts. Active Disadvantages As actively managed ETFs multiply in number, so too can their expenses. We've already see this occur with the existing traditional ETFs in the market. This erodes one if their greatest advantages: cost savings. Furthermore, active managers may be less inclined to, or interested in, adhering to a total transparency policy. If a successful manager is consistently adding alpha to his portfolio, why would he want to show the world (on a daily basis). Conclusion ETFs, both active and passive, allow investors to access global markets at a reasonable cost. The tax efficiency and transparency benefits are also obvious. It may take years for active ETFs to proliferate to a size that competes head-to-head with actively managed funds in sheer numbers and choices. But, in terms of what type of ETF you decide to employ (passive or active) the decision will ultimately boil down to one issue: do you believe that active management adds enough value to justify investing outside of an index? That verdict rests solely on the investor.

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Currency ETFs Simplify Forex Trades Investing in any market can be volatile. Minimizing risk while retaining upside potential is paramount for most investors - that's why an increasing number of traders and investors are diversifying and hedging with currencies. Different currencies benefit from some of the same things that may hurt stock indexes, bonds or commodities and can be a great way to diversify a portfolio. However, digging into currencies as a trader or investor can be daunting. Now, you can have General Electric (NYSE:GE) and the British pound in your portfolio by holding the CurrencyShares British Pound ETF (PSE:FXB) in the same account. Have an IRA? Sprinkle some euros in there by holding the CurrencyShares Euro ETF (PSE:FXE), and offset some downside risk of your S&P 500 holdings. Read on to learn more about this unique way of using currencies to diversify your holdings. Hedging Against Risk Every investor is exposed to two types of risk: idiosyncratic risk and systemic risk. Idiosyncratic risk is the risk that an individual stock's price will fall, causing you to accumulate massive losses on that stock. Rooting this kind of risk out of your portfolio is quite simple. All you have to do is diversify your account across a broad range of stocks or stock-based ETFs, thus reducing your exposure to a particular stock. However, diversifying across a broad range of stocks only addresses idiosyncratic risk. You still have to face your account's systemic risk. Systemic risk is the exposure you have to the entire stock market falling, causing you to accumulate losses across your entire diversified portfolio. Minimizing the exposure of your portfolio to a bear market used to be difficult. You had to open a futures account or a forex account and try to manage both it and your stock accounts at the same time. While opening a forex account and trading it can be extremely profitable if 25

you apply yourself, many investors aren't ready to take that step. Instead, they decide to leave all of their eggs in their stock market basket and hope the bulls win. Don't let that be you. Currency ETFs are opening doors for investors to diversify. You can now easily mitigate systematic risk in your account and take advantage of large macroeconomic trends around the world by putting your money not only into the stock market but also in the forex market through these funds. How Currency ETFs Work ETF management firms buy and hold currencies in a fund. They then sell shares of that fund to the public. You can buy and sell ETF shares just like you buy and sell stock shares. Investors value the shares of the ETF at 100 times the current exchange rate for the currency being held. For example, let's assume that the CurrencyShares Euro Trust (PSE:FXE) is currently priced at $136.80 per share because the underlying exchange rate for the euro versus the U.S. dollar (EUR/USD) is 1.3680 (1.3680 × 100 = $136.80). You can use ETFs to profit from the exchange rate of the dollar versus the euro, the British pound, the Canadian dollar, the Japanese yen, the Swiss franc, the Australian dollar and a few other major currencies. (For more on this market, see Common Questions

about

Currency

Trading.)

What makes currencies move? Unlike the stock market, which has a long-term propensity to rise in value, currencies will often channel in the very long term. Stocks are driven by economic and business growth and tend to trend. Conversely, inflation and issues around monetary policy may prevent a currency from growing in value indefinitely. Currency pairs may trend as well, and there are simple factors that influence their value and movement. These factors include interest rates, stock market yields,

26

economic growth and government policy. Most of these can be forecasted and used to guide traders as they hedge risk in the rest of the market and make profits in the forex. Economic Factors and Currency Trends Here are two examples of economic factors and the currency trends they inspire.

Oil and the Canadian Dollar Each currency represents an individual economy. If an economy is a commodity producer and exporter, commodity prices will drive currency values. There are three major currencies that are known as "commodity" currencies that exhibit very strong correlations with oil, gold and other raw materials. The Canadian dollar (CAD) is one of these. (For more on how this works, read Commodity Prices And Currency Movements.) One ETF that can be traded to profit from the moves in the CAD/USD pair is CurrencyShares Canadian (PSE:FXC). Because the Canadian dollar is on the base side of this currency pair, it will pull the ETF up when oil prices are rising and it will fall when oil prices are declining. Of course, there are other factors at play in that currency's value but energy prices are a major influence, and can be surprisingly predictive of the trend. This is especially useful for stock traders because of the effect that higher energy prices can have on stock values. Additionally, it provides another way for stock traders to speculate on rising commodity prices without having to venture into the futures market. In Figures 1 and 2, you can see 18 months of prices for the Canadian dollar compared to oil prices over the same period.

27

Figure 1: Crude oil (continuous) Source: MetaStock Pro FX

Figure 2: Canadian dollar Source: MetaStock Pro FX

As you can see, there is a strong positive correlation between these two markets. This is helpful as a hedge against stock volatility as well as the real day-to-day costs of higher energy prices. Short-term traders may look for a breakout in oil prices that is not reflected in the value of the Canadian dollar immediately. When these imbalances occur, there is opportunity to take advantage of the move the market will make as it "catches up" with

oil.

Long-term traders can use this as a way to diversify their holdings and speculate on 28

rising energy prices. It is also possible to short the ETF to take advantage of falling oil prices. Interest Rates and the Swiss Franc There are several forex relationships that are impacted by interest rates, but a dramatic correlation exists between bond yields and the Swiss franc. One ETF that can be used to profit from the Swiss franc, or "Swissie", is the CurrencyShares Swiss Franc Trust (PSE:FXF). The currency pair is notated as CHF/USD. When the Swissie is rising in value, the ETF rises as well, as it costs more U.S. dollars to buy a Swiss franc. The correlation described here involves the 10-year bond yield. You will notice in Figures 3 and 4 that when bond yields are rising, the Swissie falls, and vice versa. Depending on interest rates, the value of the Swissie will frequently rise and fall with bond

yields.

Figure 3: 10-Year Bond Yields (TNX) Source: MetaStock Pro FX

29

Figure 4: Swiss franc Source: MetaStock Pro FX

This relationship is useful not only as a way to find new trading opportunities but as a hedge against falling stock prices. The stock market has a positive correlation with bond yields; therefore, if yields are falling, the stock market should be falling as well. A savvy investor who is long the Swissie ETF can offset some of those losses.

Conclusion Currency ETFs have opened the forex market to investors focused on stocks. They add an additional layer of diversification and can also be used effectively by shorter term traders for quick profits. There are even options available for most of these ETFs.

30

31

Commodity ETF Exchange-traded funds that invest in physical commodities such as agricultural goods, natural resources and precious metals. A commodity ETF may be focused on a single commodity and hold it in physical storage or may invest in futures contracts. Other commodity ETFs look to track the performance of a commodity index that includes dozens of individual commodities through a combination of physical storage and derivatives positions. Because many commodity ETFs use leverage through the purchase of derivative contracts, they may have large portions of un-invested cash, which is used to purchase Treasury securities or other nearly risk-free assets. Commodity funds often create their own benchmark indexes that may include only agricultural products, natural resources or metals. As such, there is often tracking error around broader commodity indexes like the Dow Jones AIG Commodity Index. Even so, any commodity ETF should be passively invested once the underlying index methodology is in place. Commodity ETFs have soared in popularity because they give investors exposure to various commodities without them having to learn how to purchase futures and/or other derivative products. Americans are being hit by rising inflation and the subsequent explosion in commodity prices where it hurts most—at gas stations and grocery stores. Right alongside this growth have been the opportunities available to investors to hedge these rising prices by way of exchange traded funds (ETFs). A barrel of oil now sells for $133, which means you’re paying around $3.80 for a gallon of gas. That gallon of milk you bought for $3.87 a few days ago sold for $3.20 in 2006; and the price for a dozen eggs rose from $1.45 to $2.18 over the same time.

32

You name the commodity, if the world consumes it or relies on it to keep the gargantuan global economic wheels turning, it probably costs more today than it did yesterday. It may cost even more tomorrow. Take a look at the price of oil and gold over the past year:

ETFs Take the Mystery Out of Commodity Investing As you can see, commodities across the board have been increasing in price as supply struggles to keep up with growing global demand. We may be shoveling out more and more money to pay for life’s essentials, but there are no reason investors that shouldn’t have the opportunity to profit from and hedge these price spikes, too. Thanks to a growing wave of commodities exchange traded funds (ETFs), investors now have many options for participating in the current commodities bull market. This hasn’t always been the case, however. Before the influx of ETFs, most individual investors were simply left out in the cold. For decades, commodities remained the exclusive domain of professional traders, large companies and hedge funds—and for good reason. Futures’ trading requires an in-depth understanding of economic trends and the ability to anticipate the impact those trends will have on the cost of goods, as well as the willingness to monitor trading activity on a daily basis. It’s not for the faint-of-heart. Risk and reward are high, but prior to commodities ETFs, you had to know the “game” intimately. Now, investors have the most simple and diversified tool at their disposal to access commodities.

33

Exchange traded notes ETN - short for Exchange Traded Note - is the investment industry's latest acronym. ETNs are similar to Exchange Traded Funds (ETFs), but they differ in structure. They are issued by Barclays Bank - the ETF industry's largest provider. Three ETNs are currently available: two representing the primary commodities indexes - Goldman Sachs Commodities Index (GSCI) and the Dow Jones-AIG Commodity Index - and the other oil. How is an ETN different than an ETF? ETNs are structured products that are issued as senior debt notes by Barclays, while ETFs represent a stake in an underlying commodity. Barclays is a 300-year-old bank with $1.5 trillion in assets and an 'AA' credit rating from Standard & Poor's. This provides ETNs with a fairly dependable backing, but even with this kind of credibility, ETNs are not free of credit risk - after all, Barclays Bank will never be as safe as a central bank, such as the Bank of England. In the 1990s, for example, Barings Bank (which was as reputable as Barclays at the time) collapsed as a result of the large losses incurred by a speculative trader employed at the bank. Tax Treatment ETNs track their underlying indexes minus an annual expense of 75 basis points per year in UK. Unlike ETFs, there are no tracking errors with ETNs. Based on Barclays' recommendation, investors should treat ETNs as prepaid contracts. This means that any difference between the sale and purchase will be classified as capital gains. There are no other distributions with ETNs. In comparison, the return from 34

commodity-based ETFs will come from the interest on Treasury bills, short-term capital gains realized on the rolling of futures contracts, and long-term capital gains. Because long-term capital gains are treated more favourably than short-term capital gains and interest, the tax treatment of ETNs should be more favourable than that of ETFs; however, as of November 2006, the IRS had not made a definitive ruling on their tax treatment. For international investors, the differences are compounded as treatment for these capital gains will be treated differently in their home countries. Risk Outside of the tax treatment, the difference between ETNs and ETFs comes down to credit risk vs. tracking risk. Because ETNs possess credit risk, if Barclays goes bankrupt, the investor may not receive the return he or she was promised. An ETF, on the other hand, has virtually no credit risk, but there is tracking risk involved with holding an ETF. In other words, there is a possibility that the ETF's returns will differ from its underlying index.

The following chart represents a comparison of the GSCI ETF and ETN. Features

ETN

ETF

Issuer

Barclay's Bank

Barclay's Global Investor

Liquidity

Daily, On Exchange

Daily, On Exchange

Registration

Securities Act of 1933

Recourse

Issuer Credit

Portfolio of Securities

Principal Risk

Market and Issuer Risk

Market Risk

Weekly, To the Issuer

Daily Via Custodian

Institutional Redemption Short Sales

Size

Investment Company Act of 1940

Yes, On an Uptick or Yes,

On

Downtick

Downtick

Tracking Error

No

Yes

Expense Ratio

75 bps

75 bps

an

Uptick

or

35

Source: iShares

And the Winner Is... Now that you have a better understanding of the differences between ETN and ETF, which one should prevail? To some degree that will be determined by your tax bracket and your investment time horizon. While the biggest benefit of an ETN is that the entire gain is treated as a capital gain, this gain is also deferred until the security is either sold or matures - something that should not be taken lightly by tax-conscious, long-term investors. With an ETF, capital gains and losses are realized as each futures contract

is

rolled

into

another

one.

A ruling by the IRS would help remove the tax uncertainty of ETNs. As it stands now, the view that ETNs are classified as prepaid contracts is one that has been made by Barclays and not as an official ruling by the IRS. However, giving taxes higher priority over the quality of an investment can be perilous - the tax code and tax rates are

always

subject

to

change.

The absence of tracking risk is also of some value for ETN investors, but it should not be overrated because this has not been a big problem with ETFs. Furthermore, the question of liquidity for ETNs has not yet been answered. Conclusion The big difference between ETNs and ETFs comes down to credit risk and tax treatment. While much can be made about the counterparty risk of ETNs, is it really any different from the counterparty risk that exists in the structured product and derivatives markets today? At this point, Barclays has only introduced three ETNs, but their unique structure means that they could be applied to any tradable index. This opens the door for the potential development of many more ETNs in the future; as asset classes like timber, foreign currency bonds, foreign commercial real estate and equity

volatility

in

the

U.S

still

lack

an

index

security.

36

While the benefit of active management is arguable, there is no disputing the value that financial engineering has brought to the financial markets since deregulation took hold in the early 1970s. Financial engineering has made our markets more liquid and more efficient. The advent of ETN is no different. However, as with any new product, there are unanswered questions.

Overview of Exchange traded funds in India What are the current ETFs for Indices? Nifty BeES (NSE Nifty), Prudential SPiCE (Sensex) are a few - you can find a number of them at the Benchmark site. There are various ETFs available in India, such as: •

NIFTY BeES: An ETF launched by Benchmark Mutual Fund in January 2002.

•

Junior BeES: An ETF on CNX Nifty Junior, launched by Benchmark MF in Feb, 2003.

•

SUNDER: An Exchange Traded Fund launched by UTI in July 2003.

•

Liquid BeES: An Exchange Traded Fund launched by Benchmark Mutual Fund in July 2003.

•

Bank BeES: An ETF launched by Benchmark Mutual Fund in May 2004. Scheme Name (As on 30th June)

AUM

No 01

Sensex ICICI Prudential Exchange Traded Fund

Lakhs) 87.00

02

UTI GOLD Exchange Traded Fund

16130.34

03

Reliance Gold Exchange Traded Fund-Dividend Payout 14422.77

Sr.

(in

Rs.

Option

37

04

PSU Bank Benchmark Exchange Traded Scheme (PSU 27653.58

05

Bank BeES) Nifty Junior Benchmark Exchange Traded Scheme 1758.92

06

(Junior BeES) Nifty Benchmark Exchange Traded Scheme- Nifty 42104.94

07

BeES Liquid Benchmark Exchange Traded Scheme (Liquid 26575.55

08

BeES) Gold Benchmark Exchange Traded Scheme (Gold 16194.36

09

BeES) Banking Index Benchmark Exchange Traded Scheme 200803.30 (Bank BeES)

ETFs work? What the mutual fund does is that it appoints market participants or market makers to transact on the exchange. Retail individuals like you and me can buy through our brokers - and we can bid or ask for units at market prices. These prices are usually close to the NAV of the fund - if the market price is lower than the NAV, a market participant will buy from the exchange and sell to the fund directly, making the arbitrage difference as profit. Can you buy directly from the fund? The fund may dictate that only market participants may buy or sell directly (most closed ended funds are like this) or that you can deal with the fund only above a certain number of units, called the creation unit. The limit is usually quite high 500,000 units or so, which is out of the reach of small retail investors, but in the realm of commercial market participants. This means that if you want to deal with the fund directly you have to deal in multiples of the creation unit size. What about loads and charges?

38

As you buy directly on an exchange, funds don't charge you loads. You may of course pay brokerage to your broker, and further fees such as service tax, transaction tax etc., but these usually add up to less than 1% (compared with a typical equity fund load of 2.25%). But you must remember that there could be a difference in the NAV and the market price - the exchange price is dictated by supply and demand, which can make it a significant discount (or premium) to the NAV. In fact some ETFs trade at deep discounts to the NAV, because they must be held for a long period by a buyer before the fund will redeem (even for market participants). So the discount works against you when you're selling. Which fund do I buy? You can buy individual stocks on an exchange. But if you wanted to buy an Index, such as the Nifty or the Sensex, you have to buy ALL the stocks of the index, in the corresponding weightage. So you may need to buy 1.6 shares of Reliance, 1.2 or ONGC etc - but obviously this does not work too well for you, since you can't buy fractional shares, and buying at a higher multiple can involve lakhs of rupees! Plus, you have to keep shifting stocks around because the weightages change daily. A cheaper way is to buy Index futures - these are derivatives that will allow you to purchase or sell the Nifty or the Sensex, but on a future date. Unfortunately, such derivatives are only available for the short term - a maximum of three months. Additionally, index futures have a huge margin - Rs. 40,000 or above - per contract. ETFs are very good for index purchases. Firstly, they are much cheaper than buying stocks in the index or buying futures. The Nifty BeES by Benchmark fund, for instance, costs about 1/10th the value of the nifty (per unit), which is around Rs. 420 today. The fund management is passive - almost entirely computerised - which means fund management charges are very low (less than 1%). Add that to the fact that your entry load is nil and brokerage charges are very little, you can trade an exchange traded index fund and reap benefits of overall market growth. There are ETFs for the Nifty, the Sensex, Nifty's bank index and a few other indices. Remember though, that not all ETFs are available on all exchanges. The Nifty BeES for instance is traded only on the NSE, and the Sensex based ETFs are traded entirely on the BSE.

39

Dividends Funds declare dividends as usual, and this adds to your return. Because the NAV is close to the index value, funds have to buy and sell and this can generate substantial profits, which may be distributed as dividend. In Index based ETFs, this is truly a case where dividends may reduce NAV but very soon the NAV goes back to a value close to the Index peg. For instance, Nifty BeES declared a Rs. 8 dividend recently - that should have created a difference of Rs. 8 between the index value (Nifty divided by 10) and the fund NAV. But obviously market arbitrageurs would use the difference for profit, so the price on the exchange remained the same. That means you got Rs. 8 per unit and the price remained stable, which is a Rs. 8 profit in your pocket. Structure of ETFs in India? ETFs are securities certificates that state legal right of ownership over part of a basket of individual stock certificates. Several different kinds of financial firms are needed for ETFs to come into being, trade at prices that closely match their underlying assets, and unwind when investors no longer want them. Laying all the groundwork is the fund manager. This is the main backer behind any ETF, and they must submit a detailed plan for how the ETF will operate to be given permission by the SEC to proceed. In theory all that a fund manager needs to do is establish clear procedures and describe precisely the composition of the ETF (which changes infrequently) to the other firms involved in ETF creation and redemption. In practice, however, only the very biggest institutional money management firms with experience in indexing tend to play this role, such as The Vanguard Group and Barclays Global Investors. They direct pension funds with enormous baskets of stocks in markets all over the world to loan stocks necessary for the creation process. They also create demand by lining up customers, either institutional or retail, to buy a newly introduced ETF. The creation of an ETF officially begins with an authorized participant, also referred to as a market maker or specialist. Highly scrutinized for their integrity and operational competence, these middlemen assemble the appropriate basket of stocks

40

and send them to a specially designated custodial bank for safekeeping. These baskets are normally quite large, sufficient to purchase 10,000 to 50,000 shares of the ETF in question. The custodial bank doublechecks that the basket represents the requested ETF and forwards the ETF shares on to the authorized participant. This is a so-called in-kind trade of essentially equivalent items that does not trigger capital gains for investors.

The custodial bank holds the basket of stocks in the fund's account for the fund manager to monitor. There isn't too much activity in these accounts, but some cash comes into them for dividends and there are a variety of oversight tasks to perform. Some managers have leeway to use derivatives to track an index. This flow of individual stocks and ETF certificates goes through the Depository Trust Clearing Corp., the same US government agency that records individual stock sales and keeps the official record of these transactions. It records ETF transfer of title just like any stock. It provides an extra layer of assurance against fraud. Once the authorized participant obtains the ETF from the custodial bank, it is free to sell it into the open market. From then on ETF shares are sold and resold freely among investors on the open market.

41

Redemption is simply the reverse. An authorized participant buys a large block of ETFs on the open market and sends it to the custodial bank and in return receives back an equivalent basket of individual stocks which are then sold on the open market or typically returned to their loaners. What motivates each player? The fund manager takes a small portion of the fund's annual assets as their fee, clearly stated in the prospectus available to all investors. The investors who loan stocks to make up a basket make a small interest fee for the favor. The custodial bank makes a small portion of assets likewise, usually paid for by the fund manager out of management fees. The authorized participant is primarily driven by profits from the difference in price between the basket of stocks and the ETF and on part of the bid-ask spread of the ETF itself. Whenever there is an opportunity to earn a little by buying one and selling the other, the authorized participant will jump in. The process might seem cumbersome but it does allow for transparency and liquidity at modest cost. Everyone can see what goes into an ETF, investor fees are clearly laid out, investors can be confident that they can exit at any time, and even the authorized participant's fees are guaranteed to be modest. If one allows ETF prices to deviate from the underlying net asset value of the component stocks, another can step in and take profit on the difference, so their competition tends to keep ETF prices very close to it underlying Net Asset Value (Value of Component Stocks). Conditions for Investment in Overseas exchange traded funds (ETFs): Finance Bill for the year 2006-07 permitted a limited number of qualified Indian mutual Funds to invest, cumulatively up to US $ 1 billion, in overseas exchange traded funds. To be eligible to invest in overseas ETFs, either of the two conditions should be satisfied: i. The Mutual Fund should be in existence for a minimum period of 10 years as on

42

July 31, 2006 and managing schemes. ii. The Mutual Fund or its Sponsors should have experience, to be certified by the Trustees, of investing in foreign securities and an appropriate disclosure regarding the nature of experience should be made in the offer document.

Limits: The mutual funds can invest in overseas ETFs within overall limit of US$ 1 bn. with a sub-ceiling for individual mutual fund which should not exceed 10% of the net assets managed by them as on March 31 of each relevant year, subject to a maximum of US $50 mn. per mutual fund.

ETFs Issued in India S&P CNX NIFTY UTI NOTIONAL DEPOSITORY RECIEPTS SCHEME (SUNDER) S&P CNX NIFTY UTI NOTIONAL DEPOSITORY RECIEPTS SCHEME (SUNDER) is a passively managed open-ended exchange traded fund, with the objective to provide investment returns that, before expenses, closely correspond to the performance and yield of the basket of securities underlying the S&P CNX NIFTY Index. SUNDER will have all benefits of index funds such as diversification, low cost and a transparent portfolio and the flexibility of trading like a share. Thus it provides the best features of both open-ended fund and a listed stock. SUNDER commenced trading on NSE on July 16, 2003. ISIN code

INF789F01042

NSE symbol

UTISUNDER

Series

EQ

Face value

Rs. 100

Highlights 43

•

Face value of each units of SUNDER is Rs.100/-.

•

Valuation of each unit of SUNDER will be approximately 1/10th the value of S&P CNX NIFTY.

•

SUNDER shares will traded on NSE in compulsory dematerialised form

•

Minimum trading lot for SUNDER share in the markets will be 1 unit.

•

Creation unit size (10,000 units plus multiples of 2,000 units in case of "Authorised Participants" and 500,000 units plus multiples of 20,000 units for other investors)

•

NAV of SUNDER declared on a daily basis.

•

Initial expenses of the present scheme will be borne by UTI AMC.

Liquid Benchmark Exchange Traded Scheme (Liquid BeES) Liquid BeES (Liquid Benchmark Exchange Traded Scheme) is the first money market ETF (Exchange Traded Fund) in the world. The investment objective of the Scheme is to provide money market returns. Liquid BeES will invest in a basket of call money, short-term government securities and money market instruments of short and medium maturities. It is listed and traded on the NSE – Capital Market Segment and is settled on a T+2 Rolling basis. The Fund will endeavour to provide daily returns o the investors, which will accrue in the form of daily dividend, which will be compulsorily reinvested in the Fund daily. The units arising out of dividend reinvestment will be allotted and credited to the Demat account of the investors at the end of every month. Such units of Liquid BeES will be allotted and credited daily, up to 3 decimal places. NSDL and CDSL have waived all the charges (including Custodian charges) relating to transactions in Liquid BeES in the NSDL and CDSL depository systems respectively. 44

ISIN code

INF732E01037

NSE symbol

LIQUIDBEES

Series

EQ

Face value

Rs. 100

Entry/ Exit load

NIL

Depository charges

NIL

How can an investor invest/ redeem Liquid BeES units? An investor can invest / redeem Liquid BeES in two ways: 1.

Buy/ Sell directly on NSE, Minimum 1 unit of Rs. 1000

2.

Directly from the Fund, with a Minimum Subscription of Rs.25 lacs and minimum redemption of 2500 units on T+1 settlement subject to clearance of funds/ transfer of units.

Advantages of Liquid BeES For Investors •

Earn returns on idle funds

•

Set off trades from equity to cash and from cash to equity

•

Ability to earn higher returns than a savings account, with the same liquidity as cash

•

Ability to earn returns for less than 7 days

•

Can be used for paying margins to brokers

An Example of how Liquid BeES can be used by investors Currently, if an investor sells shares on NSE, he adopts the following procedure: 1. Sell shares worth Rs. 1,00,000 on Monday (Day T) 2. The payout will normally take place on Wednesday (Day T+2). 45

3. The broker will issue a cheque for this amount to the investor after the payout i.e. on Thursday (Day T+3). 4. The investor deposits this amount in his/ her bank on the next day (T+4). 5. The money will be available in the investor’s bank account only on next Monday (T+7). The investor does not earn any returns from the day he/ she sold to the day he/ she receives payout i.e. 7 Days. Let us say that instead, the investor adopts the following procedure using Liquid BeES: 1. Sells shares worth Rs. 1,00,000 on Monday (Day T) 2. Simultaneously buys Liquid BeES worth Rs. 1,00,000 on Monday (Day T) 3. On payout day, Wednesday (Day T+2), the payout from sale of shares will be netted off against the payin for purchase of Liquid BeES. 4. The broker will not receive pay-out of funds for sale of shares. 5. Instead, the investor directly gets 100 units of Liquid BeES in his/ her demat account on Wednesday (Day T+2). 6. He starts earning interest immediately from Day T+2 In short, the investor gets money market returns on Liquid BeES from the day he/ she receives the units in his demat account i.e. T+2, instead of the earlier scenario when he got funds in his bank account on T+7. Liquid BeES gives returns just like cash for him. Similarly, if the same investor buys shares worth Rs. 1,00,000 on NSE on Monday (Day T), he adopts the following procedure: 1. He/ she have to transfer funds into his broker’s account latest by Tuesday

(Day T+1). 2. He has to write a cheque to the broker by Monday (Day T) itself.

46

The investor loses interest on funds for at least 1 day, because he needs to transfer the funds to the broker at least 1 day before the payout. Instead, if the investor adopts the following procedure using liquid BeES, he will get returns for one extra day: 1. Buy shares worth Rs. 1,00,000 on the next Monday, 2. Simultaneously sell Liquid BeES (he needs to own the units before selling) worth Rs. 1,00,000 on Monday (Day T). 3. On payout day, Wednesday (Day T+2), the payout from the sale of Liquid BeES will be netted off against the pay-in for the purchase of shares. 4. The investor need not pay-in separate funds for purchase of shares but will receive the shares 5. The investor will receive interest on the units of Liquid BeES till the day the units of Liquid BeES remain in his/ her demat account i.e. Wednesday (Day T+2).

Junior Nifty BeES Junior BeES trades on the Capital Market segment of NSE. Each Junior BeES unit is 1/100th of the CNX Nifty Junior Index value. Junior BeES units are traded and settled in dematerialised form like any other share in the rolling settlement. ISIN code

INF732E01045

NSE symbol

JUNIORBEES

Series

EQ

Reuters code

JBES.NS

Face value

Rs. 10

47

Bank BeES Banking Index Benchmark Exchange Traded Scheme (Bank BeES) is an Open Ended Index Fund listed on the National Stock Exchange in the form of an Exchange Traded Fund (ETF) tracking the CNX Bank Index. Bank BeES is designed to provide returns that closely correspond to the total returns of stocks as represented by the CNX Bank Index. Unit of Bank BeES has a face value of Rs.10/- each and will be approximately equal to 1/10th of the value of the CNX Bank Index. Bank BeES have benefits of index funds such as low cost and a transparent portfolio. ISIN code

INF732E01078

NSE symbol

BANKBEES

Series

EQ

Reuters code

BBES.NS

Face value

Rs. 10

Bank BeES can be bought / sold like any other stock on the National Stock Exchange of India Ltd. (NSE) or the Authorised Participants and Large Investors can directly buy/sell units with the Fund in Creation Units Size. As Bank BeES can be bought / sold directly from the Fund, this mechanism provides efficient arbitrage between the traded prices and the NAV, thereby reducing the incidence of Bank BeES being traded at premium / discounts to NAV. The structure of Bank BeES is such that it does not hurt long-term investors from the inflow and outflow of short-term investors. This is because the fund does not bear extra transaction cost when buying / selling due to frequent subscriptions and redemptions.

48

Due to the various advantages, ETFs is one of the fastest growing fund structures in the world. Bank BeES will be available in Dematerialized form. This will help in consolidating with other portfolio holdings. Reliance Gold Exchange Traded Fund Reliance Gold Exchange Traded Fund (RGETF) an open ended Gold Exchange Traded Fund will track the performance of Gold Bullion. The units issued under the scheme will represent the value of gold held in the scheme. The units being offered will have a face value of Rs.100/- each and will be issued at a premium equivalent to the difference between the allotment price and the face value of Rs.100/-. RGETF offers investors a new, innovative, relatively cost efficient and secure way to access the gold market. The units are intended to offer investors a means of participating in the gold bullion market by buying and selling without the necessity of taking physical delivery of gold. The introduction of units of RGETF is intended to lower many of the barriers, such as purity, access, custody and transaction costs, that have prevented some investors from investing in gold. ETFs are bought/ sold as mentioned below: (a)

Large investors and authorized participants swap creation units for gold in physical form or in the form of cash.

(b) The secondary markets where the ETFs are traded like units of common securities on the stock exchange(s) during the trading hours. The advantages of RGETF over direct investment in gold: 1. Investors who want a cost effective and convenient way to invest in gold can get instantaneous exposure to a physical asset viz gold. 2. Its units can be traded like a share and therefore it provides the ability to buy and sell them quickly at the ruling market price (a) Unlike gold that can be sold only for a discount and by a cumbersome

process.

49

3. The expenses incurred in buying and selling units and the schemes ongoing expenses will be less than the costs associated with buying and selling of gold and storing and insuring gold bullion in a traditional gold bullion market. 4. Minimum investment in ETF in secondary markets is one unit representing approximately one gram of gold in the beginning and the weight of gold representing 1 unit keeps reducing to the extent of expenses. 5. Helps investors to diversify across asset classes. 6. Investor’s get an opportunity to access to Gold Bars conforming to LBMA

Good Delivery status, in a cost effective manner.

Security Name Reliance Mutual Fund - Gold Exchange Traded Fund

Face Value 100.00

ISIN Code

52

week 52

high price

INF733I01010 1375.00

week

low price 922.00

Reliance Gold Exchange Traded Fund will be listed on NSE and/or any other stock exchange(s) as may be decided by the Reliance Capital Asset Management Ltd. after the closure of the New Fund Offer in the form of Gold Exchange Traded Fund tracking the prices Of Gold bullion.

50

Kotak PSU BANK ETF An index is a group of stocks that an Index Service Provider selects as a representative of a market, market segment or specific industry sector. The Index Service Provider calculates, maintains and disseminates the index. Most of the indices calculated are based on market capitalization (price x outstanding equity capital) of each stock and the weightage of each stock in the index is determined based on its market capitalization. An index fund invests in securities of the index in the same weightage. The advantages of investing in an Index Fund are: 1. Diversification: Since Index Schemes replicate to a large extent the market

index, they provide diversification across various sectors/ segments/Scrips. 2. Low costs: Index Schemes are passively managed schemes, as a result of

which costs such as those relating to management fees, trade execution, research etc. are generally kept relatively low. 3. Transparency: As indices are pre-defined, investors know the securities

and proportion in which their money will be invested. 4. Arbitrage: These schemes provide low impact cost arbitrage opportunities between cash and derivatives market. 5. Operational simplicity: The ETF units are traded like stock on the stock

exchange due to which investors who are familiar with stock market trading can take the benefits of investing in an index without the complications involved in derivative trading. Kotak PSU Bank ETF is an exchange traded index fund scheme that invests in securities of a “Banking Index” in the same weightage as the underlying index. Kotak PSU Bank ETF aims to invest in stocks included CNX PSU Bank Index

Security Name

Face Value

Kotak Mahindra Mutual 10.00

ISIN Code

52 week high 52 week low price

INF373I01023 356.90

price 153.00

51

Fund

KOTAK GOLD ETF With increasing acceptability ETFs in the market, ETFs to mirror different class of assets are being introduced including ETFs to mirror the return on commodities like Gold, etc. Kotak Mahindra Mutual Fund is introducing Gold ETF based on the new regulations introduced permitting launching of Gold ETF. Three types of investors may participate in Kotak Gold ETF viz., Authorized Participants, Large Investors and Other investors. During the New Fund Offer, all three types of investors may subscribe to the Scheme in cash. During the continuous offer, Authorised Participants and Large Investors may directly buy or redeem Gold ETF units from the Fund house; however the transactions shall be in Creation Units Size. When the Gold ETF units are purchased or redeemed directly from the mutual fund, it creates/redeems units in predefined lot sizes called "portfolio deposit". Authorised Participants and Large Investors may purchase Gold ETF units either by portfolio deposit of gold (they buy gold and deposit with the Fund House) or by portfolio deposit in cash. When Portfolio deposit is made in cash, the mutual fund will buy gold; however, mutual fund may charge transaction handling cost (generally known as creation fee) for acquiring gold against the portfolio deposit in cash. Kotak Gold ETF accepts portfolio deposit in cash and gold for creation of units under the scheme.

Security Name Kotak Mutual Fund - Gold Exchange Traded Fund

Face Value 100.00

ISIN Code

52 week high 52 week low price

INF373I01015 1500.00

price 894.50

52

QUANTUM INDEX FUND The Scheme may use various S & P CNX Nifty related derivative products in an attempt to protect the value of portfolio and enhance the unit holder interest. As and when the Scheme trades in derivative market, there are risk factors and issues concerning the use of derivatives that the investors should understand. Derivative products are specialized instrument that require investment technique and risk analysis different from those associated with stocks. The use of derivative requires an understanding not only of the underlying instrument but also of the derivative itself. Derivative requires the maintenance of adequate controls to monitor the transactions entered into, the ability to assess the risk that a derivative adds to the portfolio and the ability to forecast price. There is a possibility that loss may be sustained by the portfolio as a result of the failure of another party (usually referred as the "Counter party") to comply with the terms of the derivative contract. Other risks in using derivative include the risk of mis-pricing or improper valuation of derivative and the inability of derivative to correlate perfectly with underlying assets, rates and indices. Thus, derivatives are highly leveraged instruments. The risk of loss associated with futures contracts is potentially unlimited due to the low margin deposits required and the extremely high degree of leverage involved in futures pricing. As a result, a relatively small price movement in a futures contract may result in an immediate and substantial loss or gain. However, the Scheme will not use derivative instruments for speculative purposes or to leverage its net assets. There may be a cost attached to buying index futures or other derivative instrument. Further there could be an element of settlement risk, which could be different from the risk in settling physical shares. The possible lack of a liquid secondary market for a futures contract or listed option may result in inability to close futures or listed option positions prior to their maturity date. The Scheme may also invest in overseas financial assets as currently permitted by the concerned regulatory authorities in India after obtaining necessary regulatory approvals. To the extent that the assets of the Scheme are invested in securities denominated in foreign currencies, the Indian rupee equivalent of the net assets, distribution and income may be adversely affected by changes in the value of respective foreign currencies relative to the Indian Rupee. The repatriation of capital 53

to India may also be hampered by changes in the regulations concerning exchange controls or political circumstances as well as the application to it of other restriction on investment. Whereas the Indian market was formerly restrictive, a process of deregulation has been taking place over recent years. This process has involved removal of trade barriers and protectionist measures, which could adversely affect the value of investments. It is possible that the future changes in the Indian political situation, including political, social or economic instability, diplomatic developments and changes in tax laws, Changes in SEBI/ Stock Exchange/ RBI regulations and other applicable laws/regulations could have an effect on such investments and valuation thereof. Expropriation, confiscatory taxation or other relevant developments could affect the value of investments. Face

Security Name Quantum

Index

Value Fund

-Exchange Traded Fund (ETF)

10.00

ISIN Code

52

week 52 week low

high price

INF082J01028 490.00

price 371.05

54

QUANTUM GOLD ETF The units of the Scheme may trade above or below their NAV. The NAV of the Scheme will fluctuate with changes in the market value of Scheme's holdings. The trading prices of QGF units will fluctuate in accordance with changes in their NAV as well as market supply and demand for the units. However, given that QGF units can be created and redeemed in Creation Units Size directly with the Fund, it is expected that large discounts or premiums to the NAV of QGF units will not sustain due to arbitrage opportunity available. The units will be issued only in dematerialized form through depositories. The records of the depository are final with respect to the number of units available to the credit of a unit holder. The formula for determining NAV of the units is based on the imported (landed) value of gold. The landed value of gold is computed by multiplying international market price by US dollar value. The value of gold or NAV, therefore will depend upon the conversion value of US dollar into Indian rupee and attracts all the risks attached to such conversion. Tracking error may have an impact on the performance of the scheme. However QAMC will endeavor to keep the tracking error as low as possible. There is no Exchange for physical gold in India. The Fund may have to buy or sell gold from the open market, which may lead to counter party risks for the Fund for trading and settlement. The Fund has to sell gold only to bullion bankers/traders who are authorized to buy gold. Though, there are adequate numbers of players (commercial or bullion bankers) to whom the Fund can sell gold, the Fund may have to resort to distress sale of gold if there is no or low demand for gold to meet its cash needs for redemption or expenses.

55

There is a risk that part or all of the Scheme's gold could be lost, damaged or stolen. Access to the Scheme's gold could also be restricted by natural events or human actions. Any of these actions may have adverse impact on the operations of the scheme and consequently on investment in units. The Trustee, in the general interest of the unit holders of the Scheme offered under this Offer Document and keeping in view the unforeseen circumstances/unusual market conditions, may limit the total number of Units which can be redeemed on any Business Day. Investors may note that even though this is an open-ended scheme, the Scheme would ordinarily sell and/or repurchase units only in creation unit size during the Liquidity Window. Investors holding less than creation unit size can sell their units through the secondary market on Exchange. Retail Investors would be allowed to invest only during the NFO period and the units allotted to Retail Investors during NFO can be sold only through the Secondary Market. Buying and selling units on stock exchange requires the investor to engage the services of a broker and are subject to payment of margins as required by the stock exchange/broker, payment of brokerage, securities transactions tax and such other costs. The returns from physical Gold in which the Scheme invests may under perform returns from the various general securities markets or different asset classes. Different types of securities tend to go through cycles of out-performance and underperformance in comparison of the general securities markets. The Scheme is not actively managed. The Scheme may be affected by a general price decline in the Gold prices. The Scheme invests in the physical Gold regardless of their investment merit. The AMC does not attempt to take defensive positions in declining markets.

Security Name

Face Value

ISIN Code

52

week 52 week low

high price

price 56

Quantum

Gold

Fund

-Exchange Traded Fund (ETF)

100.00

INF082J01010 780.00

491.00

57

Reliance Banking Exchange Traded Fund SCHEME FEATURES: Scheme: Reliance Banking Exchange Traded Fund Type: Open-ended, exchange listed, index linked Scheme (tracking CNX Bank Index.) Investment Pattern: Instruments Indicative asset allocation Risk Profile Securities covered by the CNX Bank Index 90% - 100% Medium to High Money Market instruments including CBLO 0% - 10% Low As the CNX Bank Index is an Equity Index, the constituents of the Index do not include debt securities. The notional exposure of Scheme in derivative instruments shall be restricted to 10% of the net assets of the Scheme. However, trading in derivatives by the scheme shall be restricted to hedging and portfolio balancing purposes as permitted by the regulations. The Scheme, in general, will hold all the securities that comprise the underlying Index in the same proportion as the index. Expectation is that, over a period of time, the tracking error of the Scheme relative to the performance of the Underlying Index will be relatively low. The Investment Manager would monitor the tracking error of the Scheme on an ongoing basis and would seek to minimize tracking error to the maximum extent possible. There can be no assurance or guarantee that the Scheme will achieve any particular level of tracking error relative to performance of the Underlying Index. Since the scheme is an exchange traded fund, it will endeavor that at no point of time the scheme will deviate from the index.

58

Investment Objective: The investment objective of Reliance Banking Exchange Traded Fund (RBETF) is to provide returns that, before expenses, closely correspond to the total returns of the securities as represented by the CNX Bank Index. However, the performance of Scheme may differ from that of the underlying index due to tracking error. There can be no assurance or guarantee that the investment objective of RBETF will be achieved. Net Asset Value: Calculated & declared every Working day Minimum Application Amount (during the NFO) Minimum of Rs 5000/- (Rupees Five thousand) and in multiples of Re 1/- thereafter. Portfolio Disclosures: Half-yearly Load Structure: During NFO and Continuous Offer Entry & Exit Load: Entry Load During NFO: 2.25% for all Investors Entry / Exit Load during Ongoing Basis There will be no entry/exit load on Reliance BETF bought or sold through the secondary market on the NSE. However, an investor would be paying cost in the form of a bid and ask spread and brokerage, as charged by his broker for buying / selling Reliance BETF. No entry or exit load will be levied on transactions with Authorised Participants and Large Investors during NFO or continuous offer. No Entry Load on direct applications i.e. applications not routed through an agent/distributor. As per the Regulations, the redemption price shall not be lower than 93% of NAV and the purchase price shall not be higher than 107% of the NAV and the difference 59

between the redemption price and purchase price shall not exceed 7% of the purchase price. In case, there are no quotes on the NSE for five trading days consecutively, an investor can sell directly to the fund with an exit load of 5% of NAV. The payout of such redemptions will be on the respective pay-out day. Listing: The units of Reliance BETF will be listed on the Capital Market Segment of the National Stock Exchange of India (NSE). The trading will be as per the normal settlement cycle. The AMC reserves the right to list the units of the Scheme on any other recognized stock exchange. Liquidity : After the close of the NFO, as RBETF would be listed on the Exchange, subsequent buying or selling by Unit holders can be made from the secondary market. The minimum number of Units that can be bought or sold on the exchange is 1 (one) unit. All investors including Authorised Participants and large investors may sell their units in the stock exchange(s) on which these units are listed on all the trading days of the stock exchange. The trading will be as per the normal settlement cycle. Alternatively, Authorised Participants and Large investors can directly buy / sell Units in blocks from the Fund in ‘Creation Unit’ size, as defined in this Offer Document on all working days. Mutual fund will repurchase units from Authorised Participants and Large investors on any business day provided the units offered for repurchase is not less than 10000 units. Minimum Redemption: The AMC will redeem units only in Creation Unit size, i.e., not less than 10,000 units.

Security Name Reliance Mutual Fund -Banking Exchange Traded Fund (ETF)

Face Value 10.00

ISIN Code

52

week 52

high price

INF733I01028 661.00

week

low price 425.00

60

ETF’s Woes in India •

The 10% STCG tax, applicable on all gains realised before 12 months, is a ‘prohibitive’ deterrent.

•

ETFs normally transfer securities to create tradable units. In India, FII’s cannot transfer securities without cash moving at the same time.

•

Ceiling on foreign ownership of Indian stocks—if an index stock has no ADR, ETFs can’t track the index.

•

Changing and ambiguous taxation policies.

•

Need to acquire a licence preclude smaller ETF players from entering.

61

CASE_STUDY GOLD ETFS Overview of Gold Ever since Gold was discovered, it has captured the imaginations of craftsman and artisans. Not only is gold pleasing to the eye, but also its resistance to corrosion and malleability has made it an ideal metal for craftsmen to mold into pieces of adornment, as well as a symbol of wealth and power. As the ancient philosopher Pinder wrote nearly 3,000 years ago, "Gold is the child of Zeus, neither moth nor rust can devoureth it". Gold also has a long history of being a store of value. Gold is primarily a monetary asset partly a commodity. More than two thirds of gold's total accumulated holdings account as 'value for investment' with central bank reserves, private players and highcarat Jewelry. Gold is considered to be a safe haven of value against inflation. Gold as medium of exchange: Gold's use as a medium of exchange predates the Roman Empire. The Chinese and Hindu cultures used Gold as the basis for their coinage. In 1816, Great Britain adopted a gold-backed paper currency and the rest of the industrialized world shortly followed suit. Prior to 1934, the United States Dollar was equal to 1/20th of an ounce of gold, redeemable upon request. Except for a brief halt of conversions from dollars for Gold during World War II, the United States Dollar was backed by Gold under an agreement known as the Bretton Woods agreement. Under Bretton Woods, the United States Dollar, and other global currencies, was tied to a value of Gold. From 1934 to 1968, this amount was $35/oz of gold. To protect the amount of Gold held in reserve for protecting the dollar, it was illegal for United States citizens to own Gold prior to President Nixon's revocation of the Gold Standard. Upon revocation of the Gold Standard, Gold became a popular investment medium. Gold Market, measure and FIX (pricing) 62

The Gold market is highly liquid and gold held by central banks, other major institutions and retail Jewelry keep coming back to the market. The pureness of Gold is measured in terms of carats, with 24 carats being 99.99 percent pure. The most popular carat rankings of Gold are 18 and 14 carat pure, representing 75% and 58.3% pure, respectively. The most popular carat for jewelry in Europe is 18 and 14, as it is in the United States. In the Middle East, India, and South East Asia, where jewelry is used as much as an investment as it is for decoration, 22 carat is more popular. In these countries, 22 carat items usually sell at a marginal markup to the metal value (usually 10 to 20%). These items can be traded in or sold back to distributors at any time. England has, in recent years, begun manufacturing 9 carat jewelry items, while Portugal has a unique designation of 19.2 carats. Given that Gold demand is so closely tied to the jewelry industry, the fortunes of both industries tend to rise and fall in tandem. Some mining companies refer to their output in terms of ounces. Others use the metric system. In general, gold is thought of in terms of the troy ounce, which takes its name from the old French city of Troyes, where there was a regular marketplace at which gold was traded. London has been the center of Gold trading since the 17th century. The Australian Gold rush of 1852, and the discovery of Gold in South Africa in 1886, solidified London's grip on the Gold market as Gold from these locals channeled through London for refining and distribution. As a center for distribution of Gold, London began a method for disseminating the price of Gold known as the "Fix" in 1919. Held at N.M. Rothchild's at 10:30 am (Morning) and at 3:00pm (Afternoon) Fix. The Fix is a single price for Gold where the members, or Fixing Seat Holder's, match up their entire buy and sell orders. The price, at which the most buy and sell orders match, or balance, is known as the Fix. The strength of the fix is that a large volume of physical Gold can be bought or sold at a single, clearly posted price. The fix is a benchmark price for many transactions worldwide, whether for mines, fabricators or central banks, because it is undisputed prices at which all six of the largest Gold trading houses are willing to do business. 63

Gold - Supply and holdings: Gold is produced from mines on every continent with the exception of Antarctica (where mining is forbidden), in operations ranging from the tiny to the enormous. The best estimates available suggest that the total volume of gold mined over history is approximately 155,500 tones, of which around 64% has been mined since 1950. The following are the world's largest producers of gold (based on the data for the year 2005):

64

Gold in India India is the largest consumer of gold in the world accounting for more than 23% of the total world demand annually. According to unofficial estimates, India has more than 13,000 tonnes of hoarded gold. Gold occupies a prominent part in rural Indian economy and a significant part of the rural credit market revolves around bullion as a security. India being the largest consumer of gold in the world, with minimal domestic supply, the demand is met mainly from imports. According to Gold Field Minerals Service, in 2001India absorbed around 700 tons from the world market, compared to 320 tons in 1994; that is without taking into account the recycling of scrap from the immense stock of close to 10,000 tones built up on the sub-continent in the last few hundred years, or gold imported for jewelry manufacture and reexport. India is the world's largest gold jewellery market by volume accounting for around 590 tonnes of consumption demand in 2005. Traditionally gold is 22 carat. Gold 65

jewellery buying is associated with a number of festivals and, in particular, with weddings. The gold given at weddings is important for women, as it traditionally remains her property. For festivals, Diwali is a traditional gold giving occasion. Dushera and Akshaya Tritya has become important festival in South India for purchase of gold. A feature of Indian demand is its extreme sensitivity to price volatility - this is the country where price factor is of most importance in affecting gold demand. Over half of demand comes from rural or rural town areas. Demand here is largely traditional. It is affected by incomes and thus the quality of the monsoon is important. In these areas gold is also important as a means of saving - a gold chain or bangle, which can be worn on the person, is considered a relatively safe way of storing wealth. Gold market in India: Banks in India sells gold in the form of small bars. Household investors buy gold in small bar forms as an investment. Gold for Jewelry purposes is bought from the jewelers and artisans. There are a few bullion dealers who buy and sell gold in large quantities to and from jewelers. Gold related instruments can be actively traded in India on the MCX as well as NCDEX exchanges. As per directions of the Forward Markets Commission, currently the trading timings are from 10.00 am to 11.30 pm Monday to Friday and from 10.00 am to 2.00 pm on Saturdays. On the expiry date, contracts expiring on that day will not be available for trading after 5 pm. The FMC however may vary these timings with due notice. The minimum amount that can be traded is 100 grams. Demand / Consumption Considerations •

Jewelry Fabrication: Jewelry fabrication is the crucial cornerstone of demand for this yellow metal. Since 1991, over 2,000 tonnes of Gold has been used annually in the production of jewelry. Gold for use in the jewelry

66

industry accounts for roughly 54% of the total demand – an estimated 54.2 million ounces. •

Industrial applications: Due to Gold's virtues of malleability, ductility, reflectivity, resistibility to corrosion and unparalleled ability as a thermal and electric conductor, Gold is used in a wide variety of industrial applications. The largest industrial user is the electronics industry. Gold is used in everything from microprocessors, semiconductors, integrated circuits, transistors, printed circuit boards, pocket calculators, washing machines, televisions, missiles and spacecraft. Japan and the United States are the largest industrial users of Gold, accounting for 45% and 30% of its industrial use, respectively.

•

Gold as investment: Gold as an investment or "hoarding" vehicle is the third largest component of demand. The concept of a bullion coin made by a government or in the form of small bars issued by banks and sold at a low premium to the base bullion amount, has endeared Gold as an investment vehicle for small investors. Together, the small bar and coin demand accounts between 100 and 200 tonnes of Gold on an annual basis.

Factors affecting gold prices: •

Central banks' sale: central banks across the world hold a part of their reserves in gold. The quantum of their sale in the market is one of the major determinants of gold prices. A higher supply than anticipated would lead to subdued gold prices and vice versa. Central banks buy gold to augment their existing reserves and to diversify from other asset classes. This acts as a support factor for gold prices

•

Producer mining interest: Bringing new mines on-line is a time consuming and at times economically prohibitive process that adds years onto potential supply increases from mining production. On the other hand, lower production has a positive effect on gold prices. Conversely excessive production capacities would lead to a downward movement in gold prices as the supply goes up.

67

•

Macro-economic factors: A weakening dollar, high inflation, the massive US trade deficits all act in favor of gold prices. The global trend of rising interest rates also had a positive impact on gold prices. Gold being regarded as a physical asset would lose its luster in a deflationary environment as gold is used effectively as an inflation hedge.

•

Geo political issues: any uncertainty on the political front or any war-like situation always acts as a booster to gold prices. The prices start building up war premiums and hence such movements. Stable situations would typically mean stable gold prices.

•

Seasonal demand: Since the demand for Gold is closely tied to the production of jewelry, Gold prices tend to increase during the times of year when the demand for jewelry is the greatest. The seasons around Christmas, Mothers Day, Valentine's Day, summer wedding season in India, Deewali, Akshaya Trithya festival in India are all major shopping seasons and hence the demand for metals tends to be strong a few months ahead of these holidays. The second and third quarters are usually seasonally low with a relative absence of major gold giving occasions.

The advantages of GOLD ETF over direct investment in gold: 1.

Investors who want a cost effective and convenient way to invest in gold can get instantaneous exposure to a physical asset viz gold.

2.

Its units can be traded like a share and therefore it provides the ability to buy and sell them quickly at the ruling market price unlike gold that can be sold only for a discount and by a cumbersome process.

3.

The expenses incurred in buying and selling units and the schemes ongoing expenses will be less than the costs associated with buying and selling of gold and storing and insuring gold bullion in a traditional gold bullion market.

4.

Minimum investment in ETF in secondary markets is one unit representing approximately one gram of gold in the beginning and the weight of gold representing 1 unit keeps reducing to the extent of expenses.

5.

Helps investors to diversify across asset classes. 68

6.

Investor’s get an opportunity to access to Gold Bars conforming to LBMA Good Delivery status, in a cost effective manner.

69

Benchmark Index: As there are no indices catering to the gold sector/securities linked to Gold, currently GETF shall be benchmarked against the price of Gold. Purity of Gold: All gold bullion held in the scheme’s allocated account with the custodian shall be of fineness (or purity) of 995 parts per 1000 (99.5%) or higher. Expenses

The above expenses are estimates only and are subject to change inter se as per actual expenses incurred. Subject to SEBI Regulations, the AMC reserve the right to modify the above estimate for recurring expenses on a prospective basis. Allotment of Units:

70

1. Each unit of GETF will be approximately equal to the closing price of 1 (one) gram of gold on the date of allotment. 2. Each unit of GETF being offered will have a face value of Rs.100/-. The number of units allotted would be the total amount invested divided by the Allotment Price. In other words The GETF being offered will have a face value of Rs100/- each and will be issued at a premium equivalent to the difference between the allotment price and the face value of Rs. 100/-. 3. GETF will be available in the Dematerialized form. 4. The applicant under the Scheme will be required to have a beneficiary account with a Depository Participant of NSDL/CDSL and will be required to indicate in the application the DP’s name, DP ID Number and its beneficiary account number with DP. 5. Authorized Participant and Large investors can directly buy / sell Units in blocks from the Fund in ‘Creation Unit’ size, as defined in this Offer Document on all working days. Since RGETF are to be issued / repurchased and traded compulsorily in dematerialized form, no request for rematerialisation of AMC will be accepted. Allotment of units in respect of applications received during NFO will be made within one month from date of closure of the NFO (subject to realization of cheque/draft and subject to receipt of minimum amount of investment during the New Fund Offer). For Subscriptions received after re-opening for continuous offer at the DISC’s within the cut-off timings and considered accepted for that day, the units will be allotted as per the applicable NAV. AMC, in consultation with the Trustees reserves the right to discontinue/ add more options at a later date subject to complying with the prevailing SEBI guidelines and Regulations. AMC, in consultation with the Trustees, reserves the right to change the

71

Load structure if it so deems fit in the interest of smooth and efficient functioning of the Scheme, on a prospective basis. CUSTODY OF THE SCHEME’S GOLD Custody of the gold bullion deposited with and held by the scheme is provided by the custodian at its Vaults in Mumbai and other places. The custodian, as instructed by the AMC, is authorized to accept, on behalf of the AMC, deposits of gold. On the instructions given by the AMC, the custodian allocates gold by selecting bars of gold bullion for deposit to the scheme’s allocated account. The AMC and the custodian enter into the custody agreements, which establish the allocated account. The gold deposited with the scheme is held in the scheme allocated account. Under the agreement entered into by the AMC and the custodian, the custodian is responsible for the safekeeping of the gold held on behalf of the AMC. The custodian is responsible for any loss or damage suffered by the scheme as a direct result of any negligence, fraud or willful default in the performance of its duties. The custodian’s liability is limited to the market value of the gold held in the scheme’s allocated account at the time such negligence, fraud or willful default is discovered by the custodian, provided that the custodian promptly notifies the AMC of its discovery. In the event of a loss caused by the failure of the custodian to exercise reasonable care, the AMC has the right to seek recovery with respect to the loss against the custodian in breach. Transfer of Gold At the end of each business day gold is transferred to the schemes allocated account. The custodian allocates specific bars of gold from its gold stocks, so that allocated gold bars represent the amount of gold credited to the extent such amount is represent able by whole bars. The bars of gold should be held directly by the Custodian. The custodian updates its records at the end of each business day to identify the specific

72

bars of gold allocated to the scheme. The withdrawal of gold from the scheme for the purpose of redemption will follow the same procedure in the reverse order. ASSET ALLOCATION PATTERN:

Presently, investment only in physical gold is allowed as per SEBI guidelines. Investment in gold or gold related instruments may be undertaken as and when permitted by SEBI. Upto 10% in securitised debt The above Asset Allocation Pattern is only indicative. The investment manager in line with the investment objective as may alter the above pattern for short term and on defensive consideration. INVESTMENT STRATEGY: The fund manager shall not try to ‘‘beat’’ the Gold Market, but aims to replicate the returns, which commensurate the returns generated, by Gold during that period. It will however endeavor to seek temporary defensive positions when markets decline or appear over valued to the extent of its investment in Money Market or other debt securities. The fund manager would not make any judgment about the investment merit of a particular security nor will it attempt to apply any economic, financial or market analysis. This style of Passive Fund Management would eliminate the risks involved with active management with regard to over / underperformance vis-à-vis a benchmark. The Fund will, in general invest a significant part of its corpus in Physical Gold or Gold Related Instruments as permitted by regulators from time to time (as per the asset allocation mentioned above). Presently, investment only in physical gold is 73

allowed as per SEBI guidelines. Investment in gold or gold related instruments may be undertaken as and when permitted by SEBI. However pending investments, the surplus amount of the Fund shall be invested in securitized debt, other debt securities, bonds and money market instruments as permitted by regulators from time to time. Also whenever good investment opportunity is not available in the view of the Fund manager, the Fund will reduce its exposure to gold and Gold Related instruments and during that period the surplus asset of the Fund shall be invested in securitized debt, other debt securities, bonds and money market instruments. However there is no assurance that all such buying and selling activities would necessarily result in benefit for the Fund. The allocation will be decided based upon the prevailing market conditions, prices of gold, macro economic environment, and the performance of the corporate sector, the debt market and other considerations. At times, such churning could lead to higher brokerage and transaction costs. To achieve its primary objective as mentioned above, the Fund would invest in gold and Gold Related Instruments as permitted by regulators from time to time. To achieve its secondary objective, the fund would invest in securitized debt, other debt securities, bonds and money market securities as permitted by regulators from time to time. These securities could include: - Obligations of Indian Companies (both public and private sector) including term deposits with the banks as permitted by SEBI/ RBI from time to time and developmental financial institutions - Certificate of Deposits (CDs) - Commercial paper (CPs) - In Securitized Debt upto 10% of the corpus. - The non-convertible part of convertible securities - Any other domestic fixed income securities

74

- Money market instruments permitted by SEBI/ RBI, having maturities upto 1 year in call money market instruments as may be provided by the RBI to meet the liquidity requirements - Any other instruments as allowed by the Regulations from time to time. - The Fund may also enter into “Repo”, or such other transactions as may be allowed to Mutual Funds from time to time. Subject to the Regulations, the investments may be in securities which are listed or unlisted, secured or unsecured, rated or unrated, having variable maturities, and acquired through secondary market purchases, RBI auctions, open market sales conducted by RBI etc., Initial Public Offers (IPOs), other public offers, placements, rights, offers, negotiated deals, etc The Scheme may also enter into repurchase and reverse repurchase obligations in all securities held by it as per the guidelines and Regulations applicable to such transactions. No investments shall be made in foreign securitised debt. How Gold based ETF’s help? Gold (or any commodity) based ETF’s try to track the gold prices and if the fund management is efficient enough, then the fund unit price almost exactly replicates the price of gold in the market. However, the advantage of (gold based) ETF is that you don’t need to have the big amount of 11,000 to invest in gold. All you can simply do is buy a unit of such gold based ETF at a price which may be anything from 10 to 1000 per ETF share, and let it gain (or loose) in percentage terms while tracking the gold prices. Hence, it gives a very good option to investors who want to invest in gold (or

other

commodities)

without

actually

buying

it.

Another advantage of gold based ETF is that you don’t need to worry about safe storage of the gold. Since the ETF is bought as a share, it sits in your demat account. Hence, the worries of theft or loss of actual gold ornament or bars is gone.

75

However, one thing you must note is that buying ETF does not guarantee any returns. Since it tracks the gold prices, it can give you losses too. If you buy ETF worth 10 Rs. a unit when the gold price is at 10,000 and after one year the gold prices fall down to 8,000, then your ETF unit cost will also come down to Rs. 8 or so. Hence, there is no guarantee

of

profits.

Another disadvantage is the cost of brokerage or fund management charges – which one should be aware of while making investments. The good thing is that the Quantum Gold Fund will be the first Gold ETF in the country without any entry load during the NFO. Investors can try their luck on gold prices!

RISK FACTORS AND SPECIAL CONSIDERATIONS GENERAL RISK FACTORS •

Mutual funds and securities investments are subject to market risks and there is no assurance or guarantee that the objectives of the Scheme will be achieved.

•

As with any investment in securities, the NAV of the units issued under the scheme can go up or down depending on the factors and forces affecting the capital market / bullion market.

•

Past performance of the Sponsor/AMC/Mutual Fund is not indicative of the future performance of the Scheme.

•

Investors in the scheme are not being offered any guaranteed or assured returns.

•

The investment decision made by the AMC may not always be profitable.

•

Reliance Gold Exchange Traded Fund is only the name of the Scheme and does not in any manner indicate either the quality of the Scheme; its future prospects or returns.

76

•

The Sponsor is not responsible or liable for any loss resulting from the operation of the Scheme beyond their initial contribution of Rs.1 lakh towards the setting up of the Mutual Fund and such other accretions and additions to the corpus.

•

The Mutual Fund is not guaranteeing or assuring any dividend. The Mutual Fund is also not assuring that it will make periodical dividend distributions, though it has every intention of doing so. All dividend distributions are subject to the availability of distributable surplus in the Scheme.

SCHEME SPECIFIC RISK FACTORS: Market Risk: Mutual funds and securities investments are subject to market risks and there is no assurance or guarantee that the objectives of the Scheme will be achieved. The NAV of the Scheme will react to the prices of gold, Gold Related Instruments and stock market movements. The Unit holder could lose money over short periods due to fluctuation in the NAV of the Scheme in response to factors such as economic and political developments, changes in interest rates and perceived trends in stock prices market movements, and over longer periods during market downturns. Additionally, the prices of gold may be affected by several factors such as global gold supply and demand, investors’ expectations with respect to the rate of inflation, currency exchange rates, interest rates, etc. Crises may motivate large-scale sales of gold, which could decrease the domestic price of gold. Some of the key factors affecting gold prices are: a. Central banks’ sale: Central banks across the world hold a part of their reserves in gold. The quantum of their sale in the market is one of the major determinants of gold prices. A higher supply than anticipated would lead to subdued gold prices and vice versa. Central banks buy gold to augment their existing reserves and to diversify from other asset classes. This acts as a support factor for gold prices. 77

b. Producer mining interest: Bringing new mines on-line is a time consuming and at times economically prohibitive process that adds years onto potential supply increases from mining production. On the other hand, lower production has a positive effect on gold prices. Conversely excessive production capacities would lead to a downward movement in gold prices as the supply goes up. c. Macro-economic factors: A weakening dollar, high inflation, the massive US trade deficits all act in favor of gold prices. The global trend of rising interest rates also had a positive impact on gold prices. Gold being regarded as a physical asset would lose its luster in a deflationary environment as gold is used effectively as an inflation hedge. d. Geo political issues: any uncertainty on the political front or any war-like situation always acts as a booster to gold prices. The prices start building up war premiums and hence such movements. Stable situations would typically mean stable gold prices. e. Seasonal demand: Since the demand for Gold in India is closely tied to the production of jewellery prices tend to increase during the times of year when the demand for jewelry is the greatest, the demand for metals tends to be strong a few months ahead of these festive seasons, especially Dushera, Diwali, Akshaya Trithya festival and summer wedding season in India. Christmas, Mothers Day, Valentine’s Day, are also major festive and shopping for Gold. f. Change in duties & levies: The gold held by the Custodian of GETF may be subject to loss, damage, theft or restriction of access due to natural event or human actions. The Trustees may not have adequate sources of recovery if its gold is lost, damaged, stolen or destroyed and recovery may be limited, even in the event of fraud, to the market value of gold at the time the fraud is discovered. The custodian will maintain adequate insurance for its bullion and custody business. The liability of the Custodian is limited under the agreement between the AMC and the Custodian which establish the Mutual Fund’s custody arrangements, or the custody agreements.

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Market Trading Risks a. Absence of Prior Active Market: Although GETF units described in this Offer

Document are to be listed on the Exchange, there can be no assurance that an active secondary market will develop or be maintained. b. Lack of Market Liquidity: Trading in GETF on the Exchange may be halted

because of market conditions or for reasons that in the view of the market authorities or SEBI, trading in GETF is not advisable. In addition, trading in GETF is subject to trading halts caused by extraordinary market volatility and pursuant to Stock Exchange(s) and SEBI ‘‘circuit filter’’ rules. There can be no assurance that the requirements of the market necessary to maintain the listing of GETF will continue to be met or will remain unchanged. GETF may suffer liquidity risk from domestic as well as international market. c. Time lag in procurement/redemption of physical gold: - Procurement of gold

bars may take upto 1 month in case of adverse shortage of gold bars. It may not be possible to sell gold bar intentionally and may delay redemption depending on the market conditions. d. GETF may trade at prices other than NAV: GETF may trade above or below

its NAV. The NAV of GETF will fluctuate with changes in the market value of Scheme’s holdings. The trading prices of GETF will fluctuate in accordance with changes in their NAVs as well as market supply and demand of GETF. However, given that GETF can be created and redeemed only in “Creation Units” directly with the fund, it is expected that large discounts or premiums to the NAVs of GETF may not sustain due to arbitrage possibility available. e. Operational Risks: GETF are relatively new product and their value could

decrease if unanticipated operational or trading problems arise. f.

Regulatory Risk: Any changes in trading regulations by the Exchange or SEBI may affect the ability of Authorised Participant and or Large Investors to arbitrage resulting into wider premium/ discount to NAV. Although GETF are proposed to be listed on Exchange, the AMC and the Trustees will not be liable for delay in listing of Units of the Scheme on Exchange / or due to

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connectivity problems with the depositories due to the occurrence of any event beyond their control. g. Political Risks: Whereas the Indian market was formerly restrictive, a process

of deregulation has been taking place over recent years. This process has involved removal of trade barriers and protectionist measures, which could adversely affect the value of investments. It is possible that the future changes in the Indian political situation, including political, social or economic instability, diplomatic developments and changes in laws and regulations could have an effect on the value of investments. Expropriation, confiscatory taxation or other relevant developments could affect the value of investments. h. Competition Risks: An investment in GETF may be adversely affected by

competition from other methods of investing in gold. The value of the units relates directly to the value of the gold held by the scheme and fluctuations in the price of gold could adversely affect investment value of the units. The ETF is designed to mirror as closely as possible the performance of the price of gold bullion and the value of units directly relate to the value of the Gold held by the Scheme less the Scheme’s liabilities (including accrued but unpaid expenses). Gold prices have been quite volatile historically. The price of gold has fluctuated from a low of $530 to a high of $726 between Jan-06 and Feb- 07 between based on the London AM Fix. - Credit & Interest Rate Risk: The Fund may also invest in Gold Related Instruments, money market instruments, bonds, securitized debts & other debt securities as permitted under the Regulations which are subject to price, credit and interest rate risk. Trading volumes and settlement periods and transfer procedures may restrict liquidity in debt investments. •

Redemption Risk – The Unit Holders may note that even though this is an open-ended scheme, the Scheme would ordinarily repurchase Units in Creation Unit size. Thus unit holdings less than the Creation Unit size can normally only be sold through the secondary market, unless no quotes are available on the Exchange for 2 trading days consecutively. Further, the 80

price received upon the redemption of GETF units may be less than the value of the gold represented by them. The result obtained by subtracting the Fund’s expenses and liabilities on any day from the price of the gold owned by the fund on that day is the net asset value of the fund which, when divided by the number of units outstanding on that date, results in the net asset value per unit, or NAV. •

Asset Class Risk: The domestic price of gold may vary from time to time. Further, the returns from the types of securities in which a Scheme invests may under perform returns from the various general securities markets or different asset classes. Different types of securities tend to go through cycles of out-performance and under performance in comparison of the general securities markets.

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Passive Investments: As GETF is not actively managed, the underlying investments may be affected by a general decline in the domestic price of gold and other instruments invested under the plan. GETF invests in the Gold & securities mentioned in the asset allocation regardless of their investment merit. The AMC does not attempt to take defensive positions in declining markets. Further, the fund manager does not make any judgment about the investment merit nor shall attempt to apply any economic, financial or market analysis.

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Tracking Error Risk: Tracking error means the variance between daily returns of the underlying benchmark (gold in this case) and the NAV of the scheme for any given period. NAV of the Scheme is dependant on valuation of gold. Gold has to be valued as per the formula provided by SEBI in its circular no. SEBI/IMD/CIR No. 2/65348/06 dated April 21, 2006. NAV so computed may vary from the price of Gold in the domestic market.

Factors such as the fees and expenses of the Scheme, cash balance, changes to the Underlying assets and regulatory policies may affect AMC’s ability to achieve close correlation with the Underlying assets of the scheme. The Scheme’s returns may

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therefore deviate from those of its Underlying assets. Tracking error could be the result of a variety of factors including but not limited to:

Delay in the purchase or sale of gold due to •

Illiquidity of gold,

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Delay in realization of sale proceeds,

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Creating a lot size to buy the required amount of gold

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The scheme may buy or sell the gold at different points of time during the trading session at the then prevailing prices which may not correspond to its closing prices.

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The potential for trades to fail, which may result in the Scheme not having acquired gold at a price necessary to track the benchmark price.

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The holding of a cash position and accrued income prior to distribution of income and payment of accrued expenses.

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Disinvestments to meet redemptions, recurring expenses, dividend payouts etc.

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Execution of large buy / sell orders

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Transaction cost (including taxes and insurance premium) and recurring expenses

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Realization of Unit holders’ funds

The scheme will endeavor to minimize the tracking error by •

Setting off of incremental subscriptions against redemptions, during liquidity window

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Use of gold related derivative instruments, as and when allowed by regulations

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Rebalancing of the portfolio.

Given the structure of GETF, the AMC expects the tracking error to be lower. The AMC will endeavor to keep the tracking error as low as possible. Under normal 82

circumstances, such tracking errors are not expected to exceed 2% per annum. However this may vary when the markets are very volatile. Tax Issues: Repurchase of “GETF” by the Fund or sale of GETF by the investor on the Stock Exchange may attract short or long term capital gain tax depending upon the holding period of the Units. Moreover, converting GETF units to Gold may also attract Wealth tax. The tax benefits described in this Offer Document are as available under the present taxation laws and are available subject to relevant conditions. The information given is included only for general purpose and is based on advice received by the AMC regarding the law and practice currently in force in India and the Unit holders should be aware that the relevant fiscal rules or their interpretation may change. As is the case with any investment, there can be no guarantee that the tax position or the proposed tax position prevailing at the time of an investment or redemption in the Scheme will endure indefinitely. In view of the individual nature of tax consequences, each investor is advised to consult his / her own professional tax advisor. Gold is subject to indirect tax not restricted to the following: Sales Tax, Octroi, VAT, Stamp Duty, and Custom Duty. Valuation of Gold Since physical gold and other permitted instruments linked to gold are denominated in gold tonnage, it will be valued based on the market price of gold in the domestic market and will be marked to market on a daily basis. However, at present, valuation of gold is governed by valuation formula prescribed under Gazette Notification dated December 20, 2006. As per this formula, the market price of gold in the domestic market on any business day would be arrived at as under: (1) The gold held by a gold exchange traded fund scheme shall be valued at the AM fixing price of London Bullion Market Association (LBMA) in US dollars per troy ounce for gold having a fineness of 995.0 parts per thousand, subject to the following:

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(a) adjustment for conversion to metric measures as per standard conversion rates; (b) adjustment for conversion of US dollars into Indian rupees as per the RBI reference rate; and (c) Addition of (i) transportation and other charges that may be normally incurred in bringing such gold from London to the place where it is actually stored on behalf of the mutual fund; and (ii) notional customs duty and other applicable taxes and levies that may be normally incurred to bring the gold from London to the place where it is actually stored on behalf of the mutual fund: Provided that the adjustment under clause (c) above may be made on the basis of a notional premium that is usually charged for delivery of gold to the place where it is stored on behalf of the mutual fund: Provided further that where the gold held by a gold exchange traded fund scheme has a greater fineness, the relevant LBMA prices of AM fixing shall be taken as the reference price under this sub-paragraph. (2) If the gold acquired by the gold exchange traded fund scheme is not in the form of standard bars, it shall be assayed and converted into standard bars, which comply with the good delivery norms of the LBMA and thereafter valued in terms of subparagraph (1). Computation of NAV NAV of Units under the Scheme can be calculated as shown below:

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Includes value of physical gold computed as described under accounting policies and market value of debt and money market instruments invested under the scheme. The NAV shall be calculated up to four decimals. The NAVs shall be issued to the press for publication on a daily basis and will also be available on Fund's website, and web-site of AMFI namely www.amfiindia.com. The NAV shall also be communicated to the recognized Stock Exchange where, the units would be listed.

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Conclusion

The National Stock Exchange (NSX), US based Stock Exchange, released the August 2008 numbers for exchange traded funds (ETF’s) and exchange traded notes (ETNs). Together, assets reached USD 596.5 billion, a 15% increase over USD 518.9 billion a year ago. Net cash inflows for the month of August totaled USD 11.4 billion, with notional trading volume at USD 1.7 trillion, a representation of 31% of all U.S. equity trading volume. As Morningstar publishes data on 220 ETFs, only 140 of which have daily volume over 100,000 shares. During the month of August 2007 the total trading volume of the 8 ETFs listed on National Stock Exchange (NSE) was Rs. 1,747.91 million ( USD 40 million) This shows that the nascent stage of the ETF market in India. The situation is very similar to that of US. In 1993, when ETF’s were launched in the US market, they were similar to that of India. But as time passed, and the flexibility of the Exchange Traded Funds to diversify into any sector and the regulations of the host country helps in formulating the market of ETF. In developed markets, the new types of ETF launched are Bond ETF’s, Commodity ETF’s, Energy ETF’s, as well as derivatives of ETF’s, etc. The market for ETF’s is at a nascent stage in India. There are hardly any volumes in the market for the product. The Gold ETF’s has the highest volume in ETF’s -India, but are not in the list of actively traded Securities. The prime reason for low volume is that market participants of big size like FII’s, Domestic Financial Institutions and, HNI’s are not participants. The brokers who are in direct touch with the market participants are also not advising the ETF products to the client. Thirdly, Regulations are a major hindrance for the development of ETF market. The watchdogs of India in capital markets such as SEBI and RBI, are not in favor of coming out with complex issues such as energy ETF’s, Bond ETF’s, etc as the Indian capital market is at its initial stages of development. In coming years, as more and more investors turn towards modern investment avenues such as Options, it will also see a rise in trading of Exchange traded Funds. 86

Abbreviations AMEX

American Exchange

AUM

Assets Under Management

ETF

Exchange traded funds

EUREX

European Exchange

GETF

Gold ETF

GSCI

Goldman Sachs Commodities Index

NAV

Net Asset Value

NYSE

New York Stock Exchange

PSU

Public Sector Undertaking

RBI

Reserve Bank Of India

SEBI

Securities & Exchange Board of India

SEC

Securities Exchange Commission, USA

S&P

Standard & Poor’s

S&P 500/ DIJA

Dow Jones Industrial Average

SPDRS

Standard and Poor’s Depositary Receipts

UITs

Unit Investment Trusts

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Bibliography •

www.amfiindia.com

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www.nseindia.com

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www.etftrends.com

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www.etfsguide.com

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www.kotakmutual.com

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www.economictimes.com

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www.benchmarksfund.com

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www.business-standard.com

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www.sec.gov

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www.reliancemutual.com

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www.investopedia.com

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