ETFs: Building a Portfolio of Equity, Debt, and Gold ETFs

Each individual strives to achieve a set of financial goals that can span the short, medium, or long term. For each of these goals, a personalized financial plan is a necessity, based on one’s risk tolerance, as it affects the type of financial instruments one invests in.

One of the most important things to remember when creating an investment portfolio is to make sure it is well diversified. This ensures that sharp movements in a particular asset class do not have a major impact on the overall portfolio return. The best way to achieve optimal portfolio diversification is through asset allocation, ie investing in a range of asset classes so that the overall portfolio risk is within your tolerance levels.


Asset allocation through ETFs

Stocks are an asset class that is an integral part of any long-term investment portfolio. If an investor is considering market cap or sector allocation, this can be achieved through exchange traded funds (ETFs).

ETFs are a type of mutual fund or basket of securities traded on an exchange. Most ETFs replicate 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 outperform the underlying index. ETFs today are available in all asset classes, be it stocks, debt or gold.


Stock ETFs

Share-based ETFs can be broadly classified into three types: market cap-based, sector-based, and smart beta.

In a market cap-based ETF, an investor has the option of investing in an index such as the Nifty, Sensex, MidCap, or SmallCap. The portfolio of such an ETF will contain the same securities as the underlying index (Nifty, Sensex or as the case may be) and in the same proportion. By doing this, an index ETF aims to generate a return comparable to the underlying index.

A sector-based ETF is designed to track a particular sector index. It should be noted that the entire portfolio is concentrated on one sector. So, if someone has a strong view of a sector and is confident in the outlook, an investor might choose a sector ETF. Today, there are several sectoral ETFs, based on PSU banks, private banks, IT, FMCG, healthcare, and so on.

The third type are the Smart beta ETFs. This type of ETF is considered a crossover between active and passive investing because of its rules-based investment approach. The portfolio will be constructed based on 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 rules-based and thus active. For example, ICICI Pru Low Vol 30 ETF is a single factor ETF. As the name suggests, the portfolio will contain 30 stocks from the large cap universe that exhibit lower volatility.


Debt ETF

Debt ETF is at a very early stage and constantly evolving in India. Currently, the options available are largely limited to liquid, gold-plated and PSU debt.


Gold ETF

Gold ETF aims to track the price of domestic physical gold and invest in gold bullion. Since it is kept in demat form, the associated costs are much lower compared to physical gold investments. As a result, gold ETF is usually the easiest option for anyone looking for long-term gold.


Wallet Allocation

When it comes to investing, the first step is determining one’s asset allocation. Depending on the risk profile of an individual, the asset allocation is unique for each individual. Now let’s assume a portfolio made up of three asset classes: stocks, debt and gold. As a rule of thumb, it is advisable to have some allocation to gold as it acts as a hedge against inflation and global risks. For this, one can consider allocating 5-10% of the portfolio to gold in the form of gold ETFs. The remaining 90% of the portfolio is divided between equity and debt.

In debt, one can invest in liquid ETFs as a holding fund. Depending on when and when attractive investment opportunities in different asset classes arise, an investor may consider switching funds from liquid ETFs to that opportunity accordingly.

Now, coming to the equity part, the question is where do you want to allocate funds? Should it be in a large, mid, or small cap space, or should it be done thematically? The best person to answer this is a financial advisor who will guide you depending on your need. Whatever the decision, there are a variety of ETFs available to help you build a low-cost portfolio. If you are also looking for some element of geographic diversification, there are several product offerings in ETF or fund of fund format.


(The author, Nitin Kabadi, is Head – ETF Business at ICICI Prudential AMC. Opinions are his own.)