The finance ministry on Sunday said it is considering to launch an exchange-traded fund (ETF) linked with PSU bank stocks, in a move to diversify and provide more options to ETF investors. The government is planning to diversify the ETF basket by including stocks of public sector banks and financial institutions.

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ETFs function like mutual funds that duplicate existing indices. In other words, the ETF portfolio consists of those stocks that come under a particular index where investors are already actively trading. The ETF has underlying assets of government-owned companies.

The government currently has two exchange-traded funds -- CPSE ETF and Bharat-22 ETF -- listed on domestic exchanges.

The CPSE ETF holds the same basket of stocks and in the same proportion as the Nifty CPSE Index while the Bharat 22 ETF will invest in similar composition and weightages as in Bharat 22 Index.

With the announcement of the PSU bank-ETF, the stock basket is likely to be linked with an index which related to the financial sector such as the Nifty PSU Bank Index. However, this is not yet confirmed.

For investors who are looking to invest in the financial sector, the PSU bank ETF can be a good option, because of the following reasons:

An ETF gives the option of investing in a diversified portfolio. Portfolio diversification help investors earn profit vis-a-vis combine a range of assets to cut the overall risk of an investment portfolio.

Since ETF functions like a mutual fund, investors do not actively trade in the market. The funds pooled in by investors will be invested in the market as a whole by a fund manager and the investment is subject to the volatility of the market.

However, for investing in mutual funds, an investor will have to choose their mutual fund portfolio. In the case of ETFs, the portfolio is readymade by the government.

For instance, CPSE-ETF comprises shares of 11 companies — ONGC, Coal India, Indian Oil Corp, Power Finance Corp, REC, Bharat Electronics, Oil India, NTPC, NBCC (India), NLC India and SJVN Ltd. The portfolio is decided by the government-appointed personnel.

Along with this, there are also chances that the government will issue the subscription for the PSU Bank ETF, when released, at a discount, similar to the subscription procedure for the CPSE ETF and the Bharat-22 ETF.

The only drawback is that even though the portfolio is diversified, the ETF is restricted to only one sector, increasing the risk for investment.