This article has first posted here on July, 18 2017. The present article includes updates on how the ETF market size has increased over the years. The article has been elaborated with videos etc.

ETF also known as Exchange Traded Funds are on a meteoric rise globally. According to a report by PWC, ETF’s in the US is going to grow to $5.9T by 2021, a whopping 23% cumulative annual growth compared to $1.6T in Europe and $560B in Asia. ETF’s are passive investment products which track an index. Exchange Traded Funds are linked to different asset classes like equities and commodities. In the US, S&P 500 would be a broad equity index so an ETF linked to S&P 500 would replicate this index. Replication here means it would track the index. ETF would not outperform the underlying index i.e. S&P 500 but rather deliver similar returns. Let’s understand a few concepts here.

Alpha means outperforming the underlying index. Mutual funds form a collective pool of underlying assets benchmarked to various indices; aim to outperform the benchmark. Example, Equity mutual funds in the US, benchmark equity indices like NASDAQ, S&P 500. An investor pays a fund management fees to the fund house to deliver superior returns compared to the market. If S&P 500 delivers a return of 10% a year, an open-ended mutual fund linked to S&P 500 is expected to return a rate higher than 10%. Hypothetically if the fund returns a 15% return, the fund has an alpha of 5% i.e. the excess return compared to the benchmark index. There are many ways to measure superior return, usually, known as a risk-adjusted return. Risk-Adjusted Returns are the Sharpe Ratio, Treynor Ratio etc. You could refer tutorials to understand the ratios. One key measure to calculate risk-adjusted return is to understand a term known as Beta. Continue reading “Exchange Traded Funds: Rise of Passive Investing…Series Begins”