ETFs: How to Build a Portfolio Using Equity, Debt & Gold ETFs
One of the most important things to remember when building an investment portfolio is to make sure that it is well diversified. This will ensure that sudden movements in an asset class will not have a large impact on the overall returns of your portfolio. The best way to achieve optimal portfolio diversification is through asset allocation, i.e. investing in a range of asset classes so that the overall portfolio risk is within your levels. tolerance.
Asset allocation via ETFs
Equities are an asset class that are an integral part of any long-term investment portfolio. Here, if an investor is considering an allocation based on market or sector capitalization, this can be achieved through exchange-traded funds (ETFs).
ETFs are a type of investment fund or basket of exchange-traded securities. Most ETFs track an index and these investments are held in the same proportion as their weight in the index. As a result, an index ETF aims to offer the same performance as the underlying index. ETFs are now available in all asset classes, be it stocks, debt or gold.
Equity-based ETFs can be categorized into three types: market cap-based, sector-based, and smart beta.
In a market capitalization based ETF, an investor has the option of investing in an index such as Nifty, Sensex, MidCap or SmallCap. The portfolio of such an ETF will hold the same securities as its underlying index (Nifty, Sensex or as the case may be) and that too in the same proportion. In doing so, an index ETF aims to generate returns similar to the underlying index.
A sector ETF is designed to track a particular sector index. The point to note here is that the entire portfolio will be focused on a single sector. So, if one has a solid vision of a sector and is confident about its prospects, then an investor can opt for a sector ETF. Today there are a variety of sector ETFs, based on PSU banks, private banks, IT, FMCGs, healthcare, etc.
The third type is that of Smart beta ETFs. This type of ETF is considered a cross between active and passive investing due to its rules-based approach to investing. The portfolio will be built on the basis of a factor such as low volatility, alpha and value, and stocks are selected on this basis. As a result, the investment philosophy remains passive, but the investment style becomes rule-based and therefore active. For example, ICICI Pru Low Vol 30 ETF is a single factor ETF. As the name suggests, the portfolio will include 30 stocks from the large cap universe that exhibit lower volatility.
ETF debt is at a very nascent stage and is constantly changing in India. Currently, the options available are largely limited to liquid, gilt, and PSU debt.
The Gold ETF aims to track the price of domestic physical gold and invest in gold bars. Since it is held in the form of demat, the associated expenses are much lower compared to physical investments in gold. As a result, the Gold ETF tends to be the easiest option for anyone looking to accumulate gold for the long term.
When it comes to investing, the first step is to determine your asset allocation. Depending on an individual’s risk profile, asset allocation is specific to each individual. Now assume a portfolio that includes three asset classes: stocks, debt, and gold. Generally, it is advisable to have some allocation to gold since it acts as a hedge against inflation and global risks. For this, we can consider allocating 5 to 10% of the portfolio to gold in the form of a gold ETF. The remaining 90% of the portfolio is split between stocks and debt.
In debt, one can invest in liquid ETFs as a portfolio fund. Depending on when and when attractive investment opportunities emerge across all asset classes, an investor may consider moving funds from liquid ETFs to that opportunity accordingly.
Now, coming to the equity portion, the question is where do you want to allocate the funds? Does it have to be in a large, mid, or small cap space, or does it have to be done thematically? The best person to answer this question is a financial advisor who will guide you according to your needs. Whatever the decision, a variety of ETFs are available to help you build a low cost portfolio. If you are also looking for an element of geographic diversification, there are various product offerings in ETF or fund of funds format.
(The author, Nitin Kabadi, is Head – ETF Business at ICICI Prudential AMC. His views are his own.)