Mutual fund vs ETF in India

An exchange-traded fund (ETF) and an open-ended mutual fund are both pooled investment vehicles regulated by the Securities and Exchange Board of India under the SEBI (Mutual Funds) Regulations, 1996. Both pool investor money and hold a portfolio of securities. Their key structural difference is the mechanism through which investors buy and sell units: mutual fund units are transacted directly with the AMC (or its registrar) at the day-end NAV, while ETF units are bought and sold on a stock exchange (NSE, BSE) at market prices throughout the trading session.

This article compares actively managed and passively managed (index) mutual funds with ETFs. The comparison of index funds (a type of mutual fund) and ETFs is covered specifically in Index fund vs ETF in India.

Structure and transaction mechanism

Open-ended mutual fund

In an open-ended mutual fund, investors submit purchase or redemption requests at any time on a business day. The AMC creates new units for purchases and cancels units on redemption. All transactions execute at the NAV declared at the end of that business day. For equity funds, the cut-off time is 15:00 IST: orders placed before 15:00 and with funds realised before 15:00 receive the same-day NAV; orders or funds after 15:00 receive the next business day’s NAV.

There is no secondary market for open-ended mutual fund units. The investor transacts only with the AMC (or registrar) and there is no liquidity risk from thin secondary market trading.

ETF

An ETF is listed on one or more stock exchanges and trades throughout the trading session like a stock. Investors buy or sell ETF units through their stockbroker’s terminal at real-time market prices. The ETF price reflects supply and demand on the exchange and may deviate from the underlying portfolio NAV (known as the intraday indicative NAV or iNAV).

Large institutional investors (authorised participants / market makers) can create and redeem ETF units with the AMC in large block sizes (creation units) in exchange for the underlying basket of securities. This arbitrage mechanism keeps the ETF market price close to NAV. However, in illiquid ETFs with low trading volumes, the bid-ask spread and price-to-NAV premium or discount can be significant.

To invest in ETFs, an investor requires a demat account and a brokerage account. ETFs are available on Zerodha Kite, Groww, Upstox, and all stockbroking platforms.

Cost comparison

ETFs are predominantly passive (index-replicating) instruments in the Indian market. Their expense ratios are lower than actively managed funds and comparable to or marginally different from index funds.

The ETF expense ratio (TER) is marginally lower than equivalent index funds for major indices. However, ETF investors also incur brokerage commissions, Securities Transaction Tax (STT), exchange transaction charges, and the bid-ask spread on each trade. Index fund investors in the direct plan incur no transaction costs beyond the TER.

For small retail investors making regular SIP-sized purchases (Rs 500–5,000 per transaction), the transaction costs on ETF purchases can exceed the TER difference relative to an equivalent index fund. For large lump-sum investors, the ETF’s lower TER and exchange-listed pricing may be more cost-effective.

Liquidity

Liquidity risk in ETFs is a practical concern in India for narrow-index, sector, and factor ETFs. The Nifty 50 ETF (e.g., Nippon India ETF Nifty 50, HDFC Nifty 50 ETF) has high daily trading volumes and tight bid-ask spreads. Smaller ETFs tracking mid-cap, international, or thematic indices have lower trading volumes, wider spreads, and higher tracking error.

Tracking error

For passive index ETFs and index funds, tracking error measures the deviation between the fund’s actual return and its benchmark index return.

Tracking error in ETFs arises from TER drag, rebalancing costs, corporate action timing differences, securities lending revenue credits, and the timing mismatch between cash dividends and index total return calculations.

Demat account requirement

A demat account is mandatory for ETF investing. Mutual funds (in SOA format) do not require a demat account; investors can invest directly with AMCs via AMC websites, Groww, Kuvera, or AMFI’s MF Central.

For investors already holding a demat account (equity stock investors using Zerodha, Upstox, or similar), the incremental requirement for ETF investing is low. For first-time investors who only want mutual fund exposure, the SOA-format mutual fund requires no demat account.

Zerodha Coin holds mutual fund units in demat form (requiring a CDSL account), merging the demat requirement for both ETFs and mutual funds under one infrastructure. However, Coin invests in regular/direct plan mutual funds (not ETFs) through its mutual fund interface; ETFs are purchased separately through Kite.

Taxation

The tax treatment of ETFs and mutual funds is governed by the same principles under the Income Tax Act, 1961, with categorisation based on the type of underlying assets (equity-oriented or debt-oriented).

Gold ETFs are treated as debt for taxation purposes (no equity STT treatment); gains are taxed at slab rate irrespective of holding period under post-2023 rules. International ETFs (FoFs or ETF-of-ETF structures) are similarly treated as specified MFs under Section 50AA.

Active vs passive universe

In the Indian context, the mutual fund universe includes a large number of actively managed schemes (large-cap, mid-cap, flexi-cap, ELSS, thematic, sector, etc.) for which no ETF equivalent exists. The ETF universe in India is predominantly passive:

• Equity index ETFs (Nifty 50, Nifty Next 50, Nifty Midcap 150, Nifty Smallcap 250, Sensex, Nifty 100 ESG)
• Gold ETFs
• Bond ETFs (Bharat Bond ETF, target-maturity bond ETFs)
• International ETFs (Nasdaq 100, S&P 500)
• Factor ETFs (Nifty 200 Momentum 30, Nifty Low Volatility 50)
• Bank and sector ETFs (Nifty Bank ETF, Nifty IT ETF, PSU Bank ETF)

Active ETFs are not a significant product category in India as of 2024, unlike the US market where actively managed ETFs have grown substantially.

SIP availability

SIPs are straightforward for mutual funds. For ETFs, SIP-like systematic purchasing requires placing a new buy order on each investment date through the broker’s platform; there is no automatic mandate infrastructure equivalent to NACH or UPI AutoPay for ETF purchases. Some brokers (Groww, Zerodha) have created SIP-like features for ETF purchases that automate the order placement on a specified date, but these are platform-specific features, not a regulated ETF SIP mechanism.

Summary comparison table

See also

• Mutual fund
• Index fund vs ETF in India
• Large-cap fund vs index fund
• Active equity vs passive equity in India
• Zerodha ETF
• Zerodha Coin
• Groww
• Demat account

References

1. SEBI (Mutual Funds) Regulations, 1996, ETF and open-ended fund structural requirements.
2. SEBI circular on ETF market-making and authorised participants norms.
3. AMFI, ETF AUM and trading volume data, amfiindia.com.
4. NSE, ETF listings and daily trading volume statistics, nseindia.com.
5. Income Tax Act, 1961, Section 50AA, Section 112A.
6. Finance (No.2) Act 2024, Capital gains rate revisions.
7. SEBI circular on T+1 settlement for equity mutual funds (2023).