Why Zerodha MF believes its liquid ETF is ideal for traders

The product caters to traders looking to park short-term funds and secure margins for future trades, as well as retail investors seeking efficient cash management.

Unlike traditional dividend-based liquid ETFs, which involve daily dividend reinvestments and fractional units, Zerodha’s growth NAV liquid ETF simplifies tracking by adding the gains directly to the NAV, offering a hassle-free alternative, besides simplifying tax implications.

However, before exploring how the Zerodha Nifty 1D Rate Liquid ETF works, let's take a quick look at dividend-based liquid ETFs.

Dividend-based liquid ETFs

Liquid ETFs invest in TREPS with a one-day maturity.

TREPS, or Triparty Repo, is a short-term borrowing and lending instrument, involving a triparty agreement between the borrower and lender, and a clearing corporation, which acts as an intermediary. TREPS are used by mutual funds to invest in short-term government treasury bills (T-Bills).

Liquid ETFs are typically traded on the Clearing Corp. of India Ltd (CCIL), offering high liquidity. Investors and traders can use these ETFs as an efficient cash management tool to maintain funds in their broking accounts while earning interest.

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For example, through this route, a trader or investor can sell stocks and buy liquid ETF units simultaneously on the same day. On a T+1 basis, stocks are debited from the demat account, and on T+1, liquid ETF units are credited, allowing the investor to start earning returns immediately.

Dividend-based liquid ETFs maintain a fixed NAV of ₹1,000, offering more predictability. Returns are generated as daily dividends and reinvested into the ETF. These reinvested units are credited to the investor's demat account on a weekly basis.

These ETFs also have some disadvantages. For instance, until the dividend units accumulate to at least one whole unit, they don’t reflect on broking platforms, However, investors can verify these units in the holding statement of the depository.

Besides, fund houses provide a reinvestment statement and dividend statement showing credited units over time, said a mutual fund executive. “This shows the units that have got credited to the investor’s account over a period of time, against the units purchased by the investor," said the product head of a fund house, seeking anonymity.

Some dividend-based liquid ETFs do not reinvest dividends but pay the dividend directly to the investor in cash.

However, tracking returns is challenging as dividend-linked units are paid out daily after TDS(tax deducted at source) deduction. Investors need to monitor fractional units to determine their final tax liability.

There is a tax event daily as dividends are generated daily. Dividends are paid after TDS of 10%, and the dividends are taxed at the investor's slab rate. To be sure, some of the dividend-based liquid ETFs were launched when dividends were tax-free in the hands of the investor.

Fractional units cannot be sold directly on stock exchanges, and one of the options is to transfer to the mutual fund’s demat account through an off-market transfer.

Growth NAV Liquid ETFs

A growth NAV liquid ETF, such as Zerodha’s new offering, has no dividend or reinvestment option, eliminating fractional units. Gains are added directly to the NAV.

“The feedback we got from investors suggested there is demand for products that can ease the trackability," said Vishal Jain, chief executive officer, Zerodha Mutual Fund. “Hence, we thought of a growth NAV liquid ETF, where nothing is going in and out of the investor's account. The NAV reflects day-to-day returns, which can be tracked easily."

"I was invested in one of the dividend-based liquid ETFs through a small-case. Every week, I would get dividend units, but didn't know at what rate dividends were getting issued. Also, I didn't know how to exit the fractional units. Now, the small-case has shifted to Zerodha's ETF. Returns are easier to track as we can simply monitor the movement in the ETF's NAV," said Sarang Pitale, 44, a Pune-based investor and IT professional.

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In terms of taxation, capital gains tax applies at the investor's slab rate for both growth NAV and dividend NAV ETFs. However, capital gains offer more flexibility, as taxes are only triggered upon redemption. In contrast, dividend-based liquid ETFs generate and reinvest dividends daily, resulting in a daily tax event.

Investors can also offset short-term capital losses against gains, reducing their overall tax liability.

Should You Opt for Zerodha's ETF?

Liquid ETFs are suitable for traders and active investors who want to avoid the hassle of transferring money between their bank accounts and the broking accounts, and then re-deploy it for investing or trading.

Liquid ETFs can offer better returns than bank savings accounts, typically in the range of 5.75-6% per annum. They also provide a better alternative to idle funds in a broking account, and can be pledged for margin collateral while continuing to earn gains.

Zerodha’s growth NAV ETF eliminates the need to track fractional units to determine returns and the tax impact. Investors should check the total cost of buying an ETF, as most brokers don’t charge brokerage on liquid ETF transactions.

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Zerodha’s growth NAV ETF has among the lowest total expense ratio (TER) compared to its peers at 0.26%.

However, considering that it is a new fund with just a six-month track record, investors may choose to wait for it to build a history before using it for cash management needs. Those who opt to invest immediately should check the intraday NAV (iNAV) on Zerodha MF’s website before purchasing or selling the units. iNAV is used to calculate the fair value of an ETF.