ETF investing on Zerodha

Exchange-Traded Funds (ETFs) are open-ended mutual fund schemes that are listed and traded on stock exchanges in real time, similar to equity shares. Unlike traditional mutual funds where units are bought and sold at end-of-day NAV, ETFs have a continuously updating market price during trading hours. Zerodha provides full access to all ETFs listed on the National Stock Exchange (NSE) and Bombay Stock Exchange (BSE) through Kite. ETF investing through Zerodha carries zero brokerage for delivery (CNC) orders, making it cost-effective for long-term investors.

Types of ETFs available on Zerodha

Equity index ETFs

The largest category by assets under management (AUM), equity index ETFs track broad market indices. Prominent examples:

• Nifty 50 ETFs: Multiple ETFs from AMCs such as Nippon India, HDFC, SBI, Kotak, UTI, and ICICI Prudential track the Nifty 50 index. The Nippon India Nifty BeES is the oldest and largest Nifty 50 ETF in India.
• Nifty Next 50 ETF: Tracks the 50 largest companies below the Nifty 50.
• Nifty Midcap 150 ETF: Exposure to mid-cap segment.
• Sensex ETF: Tracks the BSE Sensex.
• Nifty Bank ETF: Tracks the Nifty Bank index.
• Nifty IT ETF, Nifty Pharma ETF: Sectoral ETFs.

Gold ETFs

Gold ETFs track the domestic gold price (IBMA published price). Each unit of a gold ETF represents approximately 0.01 gram of physical gold (the exact gram backing varies by fund and over time due to expense ratio deductions). Prominent gold ETFs: Nippon India Gold BeES, HDFC Gold ETF, SBI Gold ETF.

Gold ETFs provide liquid, exchange-traded gold price exposure without storage costs or making charges. Capital gains tax on gold ETF sale (unlike Sovereign Gold Bonds) is not exempt; gains are taxable.

Debt ETFs

• Liquid BeES (Benchmark Exchange Traded Scheme - Liquid): Invests in money-market instruments (repo, T-Bills, short-duration debt). NAV grows daily; dividends are declared daily and reinvested as new units. Liquid BeES is widely used by investors as a cash-equivalent parking instrument within the Zerodha ecosystem and is accepted as margin collateral.
• BHARAT Bond ETF: A government-backed ETF series investing in PSU bonds with defined maturity dates (target maturity ETFs). Issued by Edelweiss MF.

International ETFs

A limited set of ETFs provides international exposure through fund-of-funds structures. Examples include Mirae Asset Hang Seng Tech ETF and Kotak Nasdaq 100 ETF. These are subject to SEBI’s overseas investment limits for Indian mutual funds.

CPSE ETF and PSU ETFs

CPSE ETF tracks Central Public Sector Enterprise stocks. It has been used by the government for disinvestment; the government periodically sells CPSE ETF units at a discount to NAV through Further Fund Offers (FFOs).

REITs and InvITs (exchange-traded)

REITs and InvITs are structured investment products that trade on exchanges like ETFs. They are covered in separate articles.

How ETFs trade on Zerodha

ETFs trade exactly like equity shares on Kite. Investors:

1. Search for the ETF ticker (e.g., “NIFTYBEES” for Nippon Nifty BeES on NSE).
2. Place a limit or market order using CNC (delivery) for long-term holding or MIS for intraday.
3. Units are credited to the demat account at CDSL on T+1.

Market price vs NAV

The market price of an ETF on the exchange may differ slightly from its intraday indicative NAV (iNAV). Authorised Participants (APs), typically large institutional investors, arbitrage this gap by creating or redeeming ETF units in exchange for the underlying basket of securities. For liquid ETFs with active APs, the market price typically stays within 0.1% to 0.5% of iNAV. Illiquid ETFs can trade at wider premiums or discounts.

Liquidity considerations

For popular ETFs (Nifty BeES, Liquid BeES), the exchange-traded market is highly liquid. For sectoral ETFs or narrow-index ETFs, trading volume can be low, resulting in wide bid-ask spreads. Retail investors should use limit orders (not market orders) for less-liquid ETFs.

Expense ratio and tracking error

The Total Expense Ratio (TER) of an ETF is deducted from the fund’s assets, reducing NAV over time. SEBI caps TER for ETFs at lower levels than active funds:

• Equity index ETFs: typically 0.05% to 0.20% per annum.
• Gold ETFs: typically 0.50% to 0.90% per annum.
• Liquid ETFs: near zero.

Tracking error measures how closely the ETF’s returns match the index returns. A lower tracking error indicates better index replication. SEBI mandates annual tracking error disclosure by ETF AMCs.

Brokerage and charges

SIP in ETFs

ETFs cannot be set up as automatic monthly SIPs through Kite in the same way as mutual funds on Coin. However, investors can:

• Place manual monthly CNC orders on Kite (no automation).
• Use Coin to invest in index mutual funds that replicate the same index (fully automated SIP via NACH/UPI).

For investors who prefer direct ETF ownership, the GTT (Good Till Triggered) order on Kite can be used for disciplined buying at defined price levels, though this is not a time-based SIP mechanism.

Pledging ETFs as margin collateral

ETF units (especially Liquid BeES and Nifty BeES) can be pledged through Zerodha’s pledge mechanism to generate margin for F&O trading. Liquid BeES typically attracts a 10% haircut (90% of market value is usable as margin). See the pledge and collateral margin on Zerodha article for the complete pledge workflow.

Tax treatment

Equity ETFs (minimum 65% equity)

• STCG: Holding period less than 12 months; 15% flat tax under Section 111A.
• LTCG: Holding period 12 months or more; 10% on gains above Rs 1 lakh per year under Section 112A.

Debt ETFs (including Liquid BeES)

Post Finance Act, 2023, debt ETF gains are taxed at slab rate regardless of holding period (for units purchased on or after 1 April 2023). The LTCG with indexation treatment is no longer available for new purchases.

Gold ETFs

Gold ETFs are classified as debt-oriented funds for tax purposes (the underlying is gold, not equity). Post Finance Act, 2023:

• Gains taxed at slab rate for units purchased on or after 1 April 2023.
• Unlike SGBs, there is no capital gains tax exemption for gold ETF redemption.

Comparison: ETF vs direct index fund via Coin

Long-term passive investors typically choose index funds on Coin for convenience of SIP automation. Short-term or active investors prefer ETFs for intraday liquidity.

References

1. SEBI (Mutual Funds) Regulations, 1996, ETF provisions.
2. SEBI Circular, TER caps for ETFs and index funds.
3. Income Tax Act, 1961, Sections 111A, 112A.
4. Finance Act, 2023, Debt fund and gold ETF taxation amendments.
5. NSE, ETF Market Making guidelines and AP framework.
6. AMFI, Monthly ETF AUM and tracking error data.