Equity ETF in India

An equity exchange-traded fund (equity ETF) in India is a passively managed open-ended fund that tracks a specific equity index (such as the NIFTY 50, SENSEX, NIFTY Bank, or NIFTY Midcap 150), with its units listed and traded continuously on a stock exchange (NSE or BSE) during market hours. Unlike a conventional open-ended mutual fund (in which units are purchased and redeemed at the end-of-day NAV), equity ETF units trade intraday on the exchange at market prices that approximate the fund’s NAV, enabling real-time entry and exit.

SEBI introduced the regulatory framework for ETFs in India in 2001 (SEBI (Mutual Fund) Regulations amendment). Nifty BeES, launched by Benchmark Mutual Fund in December 2001, was India’s first equity ETF. The category has grown substantially since 2015, driven primarily by Employees’ Provident Fund Organisation (EPFO) investments in NIFTY 50 and SENSEX ETFs.

Regulatory framework

SEBI categorisation

Under the SEBI October 2017 scheme categorisation circular, equity ETFs are categorised as “Other Schemes – ETFs”. Key regulatory features:

• Multiple ETF schemes: Unlike actively managed equity categories (where AMCs may operate only one scheme per category), AMCs may operate multiple ETFs each tracking a different index.
• Replication mandate: Equity ETFs must replicate their underlying index, maintaining the same stocks in the same weights (or a close approximation via optimised replication).
• Exchange listing: Units must be listed on at least one recognised stock exchange (NSE or BSE).
• Market maker requirement: AMCs must appoint authorised participants (APs) and market makers to provide two-way quotes (buy and sell) on the exchange, ensuring liquidity and tight bid-ask spreads.

Creation and redemption mechanism

The ETF creation/redemption mechanism operates at two levels:

Primary market (large lot creation/redemption):

• Authorised participants (typically large institutional investors or stockbrokers) can create new ETF units by delivering a “creation basket” of securities (in the same proportion as the index) to the fund in exchange for new ETF units.
• APs may also redeem ETF units in large lots in exchange for the underlying securities basket.
• This mechanism keeps ETF prices aligned with NAV: if the ETF trades at a discount to NAV, APs buy ETF units and redeem for the cheaper underlying basket; if it trades at a premium, APs buy the underlying basket and deliver it to create cheaper ETF units.

Secondary market (retail trading):

• Individual investors buy and sell ETF units on the exchange through a demat and trading account.
• Retail investors do not interact with the primary creation/redemption mechanism.

Equity ETF structure versus index mutual fund

The choice between a NIFTY 50 ETF and a NIFTY 50 index fund often depends on investment size, trading frequency, and whether the investor has a demat account:

• Large, lump-sum, infrequent investments may favour ETFs for lower TER.
• Regular SIP investors without demat accounts typically prefer index funds.

Tracking error

Equity ETF tracking error is influenced by:

• Cash drag: Cash held for operational purposes rather than invested in the index.
• Dividend lags: Dividends received as cash take time to be reinvested.
• Corporate actions: Stock splits, bonus issues, and index rebalancing require adjustments.
• Securities lending income: Some ETFs lend their holdings to generate additional income, partially offsetting TER.
• Bid-ask spread cost: When buying index constituents, the fund pays the ask; when selling, it receives the bid.

For major NIFTY 50 ETFs with large AUM, tracking error is typically very low (0.01% to 0.05% per annum), comparable to or lower than index mutual funds.

Taxation

Equity ETFs tracking domestic equity indices (NIFTY 50, NIFTY Bank, NIFTY Midcap 150, etc.) are equity-oriented funds.

Capital gains (Finance Act 2024):

Securities Transaction Tax applies on buy/sell transactions (both equity ETF purchase and redemption through the exchange carry STT). The grandfathering rule for LTCG applies to units acquired before 31 January 2018. See capital gains tax in India and ITR-2 for reporting.

Major equity ETF categories by index

Broad market ETFs

• NIFTY 50 ETF: Tracks the 50 largest companies; the core large-cap index.
• SENSEX ETF: Tracks BSE’s 30-stock flagship index.
• NIFTY 100 ETF: Tracks the top 100 large-cap companies.
• NIFTY 500 ETF: Tracks the top 500 companies across all market-cap segments.

Mid-cap ETFs

• NIFTY Midcap 150 ETF: Tracks the 101st to 250th companies.

Sectoral ETFs

• NIFTY Bank ETF: Tracks listed banks on NSE; one of India’s highest-volume ETFs.
• NIFTY IT ETF: Tracks information technology companies.
• NIFTY Pharma ETF: Tracks pharmaceutical companies.
• NIFTY Infrastructure ETF: Infrastructure-linked companies.

Factor/Smart-beta ETFs

• NIFTY Alpha 50 ETF: High-alpha stocks.
• NIFTY 100 Low Volatility 30 ETF: Low-volatility stocks within the NIFTY 100.
• NIFTY Quality 30 ETF: High-quality stocks screened by return on equity, debt-to-equity, and earnings variability.

See smart-beta and factor funds in India for a detailed treatment of factor ETFs.

Debt ETFs

Debt ETFs such as the Bharat Bond ETF and the CPSE ETF are specialised government-linked ETFs with different characteristics.

EPFO and government investment in equity ETFs

The Employees’ Provident Fund Organisation (EPFO) has been a major institutional investor in NIFTY 50 and SENSEX ETFs since 2015, when the government mandated that 5% (later raised to 15%) of EPFO’s incremental corpus be invested in equity ETFs. By 2025, EPFO’s equity ETF investment has accumulated to tens of thousands of crores. This large, regular, passive buying creates a structural demand for large-cap ETFs and is often cited as a stabilising factor in Indian equity markets during periods of foreign institutional investor (FII) selling.

Similarly, the National Investment and Infrastructure Fund (NIIF) and other government bodies have invested in PSU-linked ETFs such as the CPSE ETF and Bharat Bond ETF.

Exemplar schemes

Major equity ETFs in India by AUM:

• Nippon India ETF Nifty 50 BeES (Nifty BeES) – India’s first and largest NIFTY 50 ETF
• SBI ETF Nifty 50 (SBI Mutual Fund) – EPFO’s primary investment vehicle
• HDFC Nifty 50 ETF (HDFC Mutual Fund)
• ICICI Prudential Nifty 50 ETF (ICICI Prudential Mutual Fund)
• Kotak Nifty 50 ETF (Kotak Mahindra Mutual Fund)
• SBI ETF Sensex (SBI Mutual Fund)
• Nippon India ETF Bank BeES (NIFTY Bank ETF)
• ICICI Prudential Nifty Bank ETF

These are cited for reference only.

Liquidity considerations

The tradeable liquidity of an equity ETF on the secondary market depends on:

1. AUM: Larger ETFs attract more market maker activity and generally have tighter bid-ask spreads.
2. Market maker activity: SEBI requires AMCs to appoint market makers; the depth of their quoting determines intraday liquidity.
3. Underlying index liquidity: ETFs on highly liquid indices (NIFTY 50, NIFTY Bank) have much better secondary market liquidity than ETFs on less liquid indices.

Small-cap or factor ETFs with smaller AUM may have wide bid-ask spreads, increasing the effective cost of trading.

Suitability

Equity ETFs are suitable for:

• Investors with demat and trading accounts who want intraday flexibility.
• Large institutional investors and HNIs who can trade in creation/redemption lot sizes.
• Investors who want the lowest possible expense ratio for passive large-cap equity exposure.
• EPFO and other institutional investors making periodic, large-lot equity investments.

Equity ETFs are less suitable for:

• Retail SIP investors without demat accounts (index funds are simpler).
• Investors in ETFs with low trading volumes where bid-ask spreads are wide.
• Investors in illiquid small-cap or niche-sector ETFs where the secondary market is thin.

Regulatory oversight

Equity ETFs are regulated by SEBI under the SEBI (Mutual Funds) Regulations, 1996. The mutual fund industry in India framework governs fund operations. NSE and BSE regulate the listing and trading of ETF units.

References

1. SEBI Circular SEBI/HO/IMD/DF3/CIR/P/2017/114, “Categorisation and Rationalisation of Mutual Fund Schemes”, 6 October 2017.
2. SEBI circulars on ETF structure, authorised participants, and market-making requirements.
3. Finance Act 2024, Section 112A.
4. EPFO, Guidelines on investment in ETFs, 2015 and subsequent circulars.
5. SEBI (Mutual Funds) Regulations, 1996, as amended.