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What is an Auto ETF? Should you invest in it?

22 Sep 2022 0 COMMENT

Introduction

Typically, bullish market conditions are an investor's delight. Conversely, bearish markets may get you worried. But, falling stock prices may not necessarily be a bad thing. It serves as the perfect time to capitalize on sectors with potential at low-market prices. The Automobile industry is one such promising sector that you can explore. The advent of electric vehicles and supportive government policies are paving the way for this sector's rising demand.

But, what is the most suitable way to invest in the auto sector? Is it through directly buying Stocks? Or via Mutual Funds? Or is there another interesting investment instrument that will give you the perks of Stocks and Mutual Funds - An Auto ETF? You must understand all these tools well to pick the correct answer for this question. In this article, we will discuss Auto ETFs.

What is an Auto ETF?

Before delving into the details of an Auto ETF, you must first understand the concept of an ETF.

Additional Read: What is ETF? Advantages of Exchange Traded Funds

An ETF or an Exchange Traded Fund is a low-cost tool through which you can invest in a group of assets or stocks. Its structure is like an Index Mutual Fund. Its asset allocation is a replica of a market benchmark index, such as Sensex, Nifty, etc. When you buy an ETF share, you buy a unit’s stake in all the assets that the ETF invests in. ETFs can be viewed as cusp between stocks and Mutual Funds as they inherit some features from each of these tools. The market price of an ETF share fluctuates throughout the trading day, just like a stock. And you can trade an ETF share just like you trade the share of a company.

Additional Read: ETFs Vs Stocks - Difference

Additional Read: Mutual funds vs ETFs: Know the difference

ETFs are designed to meet different investment objectives. An Auto ETF is a tool that invests in companies manufacturing automobiles such as cars, bikes, trucks, commercial vehicles, vans, etc. An Auto ETF also invests in automobile ancillaries and supply parts. It gives you an exclusive and diversified exposure to the automobile sector. In other words, the investment basket of this ETF consists of only automobile shares.

The performance of an Auto ETF depends on the performance of the underlying automobile companies that the ETF is invested in. And the performance of the overall auto industry is proportional to consumer spending and economic health. This means that when the economy swells, people have more spending power, which raises the demand for a better lifestyle. It translates into more spending on automobiles and makes the auto industry bullish.

What are the Pros and Cons of investing in an Auto ETF?

Pros of investing in an Auto ETF

Diversification

One of the unmissable advantages of an Auto ETF is the diversified exposure it offers to the automobile industry. The fragmented asset allocation hedges the risk of ill performance of some of the companies in the investment kitty.

Cost-efficient

Since Auto ETFs mimic the auto-based benchmark index, they come at a low cost. ETFs, in general, have a lower expense ratio compared to Mutual Funds due to their passive management. Furthermore, a longer holding period in these ETFs leads to better tax efficiency.

Low-ticket size

You can enter into an Auto ETF investment even if your investment appetite is less. If you choose to invest in the auto industry by buying stocks directly, the minimum funds you require will be equivalent to one company’s share’s price. But with an auto ETF, in an amount lesser than that, you can hold a stake in multiple companies.

Focussed

As this ETF invests only in auto shares, there is a focus. Assuming that the demand for electric vehicles is going to boom in the coming years, you can say to an extent that the performance and returns of an auto ETF may steadily spike in the years to come.

Liquidity

An Auto ETF share functions like an automobile company share. You can trade it throughout the trading hours at its market price. Hence, Auto ETFs are high in liquidity.

Cons of investing in an Auto ETF

No guaranteed returns

An Auto ETF allocates funds in equity assets alone. It misses out on fixed-income assets like bonds, etc. The pure equity asset allocation does not guarantee returns and may be volatile especially in the short run.

Inadequate diversification

An auto ETF is a sectoral ETF that provides coverage of specifically the Auto industry. The absence of any other industry in this ETF means that if the auto sector, as a whole, crashes or does not perform well, your auto ETF share returns will sink.

Investing in an Auto ETF

You must decide to invest in an Auto ETF after carefully weighing its pros and cons. An Auto ETF is a good pick if you want definite exposure to the auto sector but do not have much stock-picking expertise.

Additional Read: Investing in Exchange Traded Funds (ETFs) with a Demat Account

Conclusion

Equity holds the reputation of delivering high returns over a long period. Hence, a wise way to have a profitable Auto ETF investment is to be invested here for a long tenure. Also, remember that since the auto industry is cyclical, it is prone to volatility. Hence, an Auto ETF investment must be one of your investments and not your only investment.

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