What is a PSU Bank ETF and How it Works?

In India, there are many attractive market-linked investment options for long-term wealth creation. Exchange-Traded Funds (ETFs) are one among them. One of the defining characteristics of ETFs is that they offer exposure to a wide range of diversified securities. Furthermore, they’re listed on an exchange and can be freely bought and sold, just like stocks.  

Exchange-traded funds often aim to replicate the performance of a specific market index, which can either be a broad-market index or a sector-specific index. In this article, we’re going to be looking at a sector-specific fund, namely the PSU bank ETF. Here’s everything you need to know.        

What is a PSU Bank ETF?

A PSU bank ETF is an exchange-traded fund whose primary objective is to replicate the performance of a PSU bank index. To achieve its objective, the ETF invests in the same diversified portfolio of different public sector banking institutions as that of the index. 

PSU bank ETFs are registered with the Securities and Exchange Board of India (SEBI) and are listed on both the premier stock exchanges of India – the National Stock Exchange (NSE) and the Bombay Stock Exchange (BSE). Since the fund is listed on exchanges, investors can freely purchase and sell its units on the secondary market during market hours without any restrictions. 

Since the main aim of a PSU bank ETF is only to replicate the performance of the PSU bank index and not outperform it, they’re generally passively managed. This helps keep the expense ratio very low compared to actively managed mutual funds, making it a good option for investors looking for cost-effective long-term investments. 

How does the ETF work?

Now that you’re aware of what a PSU ETF is, let’s take a look at how it works with the help of a hypothetical example. 

Assume you wish to include a diversified basket of PSU banking stocks in your investment portfolio. Although you could invest in individual PSU bank stocks, doing so can not only be cumbersome but may also increase your investment costs, like brokerage and taxes significantly. 

Here’s where a PSU bank ETF comes into the picture. When you purchase the units of such an ETF, you gain exposure to all of the constituents of the PSU bank index that the fund aims to replicate. Furthermore, the transaction costs of purchasing such an ETF are also very low compared to direct equity investments. And since the exchange-traded fund is passively managed, the expense ratio also tends to be very nominal.  

Since the PSU bank ETF is listed and traded on exchanges like stocks, all you need to do is place a buy order for the number of units you wish to purchase through your stockbroker’s trading portal. Once the buy order is executed, the units of the ETF you purchased will be credited to your linked demat account. 

Similarly, if you wish to liquidate your ETF holdings, simply place a sell order for the number of units you wish to liquidate through your stockbroker’s trading platform. Once the sell order is executed, the units of the ETF you sold will be debited from your demat account and the sale proceeds will be credited to your trading account. The difference between the selling price and the purchase price will be the returns from your investment. 

Factors to Consider Before Investing in PSU Bank ETFs

As an investor, you may be tempted to invest in PSU ETFs. However, before you do, there are a few factors you need to consider. Here’s a quick overview of some of the key things you need to keep in mind. 

• Demat Account 

Like stocks, the units of the ETF you purchase through a stock exchange are stored electronically in a demat account. Therefore, to invest in a PSU bank ETF, you need an active demat account. 

• Dividend Payments 

PSU bank ETFs pay dividends provided the public sector banking institutions in the funds’ portfolio declare them. However, the frequency and amount of dividend you’re entitled to may vary depending on factors like the number of units you hold and the financial performance of the stocks, among others. Furthermore, as an investor, you can choose to receive these dividends in cash or reinvest them into the fund to get more units. 

• Tax Implications 

There are several tax implications you need to be aware of when investing in a PSU ETF. For example, the dividends from the fund are subject to a Dividend Distribution Tax or DDT at the rate of 15%. 

Furthermore, the profits from your ETF investment are also subject to capital gains tax. The rate of tax applicable on the profits will vary depending on how long you hold your ETF investments. 

For instance, if the holding period is more than 12 months, the profits will be categorised as Long-Term Capital Gains (LTCG) and taxed at 10%. However, LTCG tax is only applicable if your profits exceed ₹1 lakh in a financial year. Meanwhile, if the holding period is less than 12 months, the profits will be categorised as Short-Term Capital Gains (STCG) and taxed at 15%. 

• Net Asset Value (NAV)

The Net Asset Value (NAV) is the price per unit of the ETF. Unlike regular mutual funds, the NAV of an exchange-traded fund such as the PSU bank ETF is updated in real-time as and when its units are bought and sold on the exchanges. 

• Risk

PSU bank ETFs, like most other market-linked investment options, have their own set of risks. As an investor, you need to be aware of what they are before investing. Some of the risks that the exchange-traded fund is prone to include market risk, regulatory changes, financial performance of the portfolio banks and market volatility, among others. 

• Expense Ratio 

The expense ratio of PSU bank ETFs tends to be very nominal compared to that of regular mutual funds. However, not all funds tend to levy the same expense ratios. In fact, they may differ depending on the Asset Management Company (AMC) managing the fund. Therefore, it is advisable to always check and compare the ratios of different funds before investing. 

• Investment Methods 

There are two ways to invest in a PSU bank ETF. You can either choose to invest a lump sum amount in the fund or start a Systematic Investment Plan (SIP) where you invest a fixed sum of money regularly over a period of time. If you’re looking for long-term wealth creation, an SIP is a good way to invest.

Conclusion

With this, you must now be aware of what PSU bank ETFs are and how they work. Now, although these funds are a good option for long-term wealth creation, they also offer short-term trading opportunities. However, if you plan to trade in some of the best PSU bank ETFs for short-term gains, remember to check if the fund has enough liquidity to enter and exit your positions comfortably. 

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